Trading holds a certain allure to many investors. But is it better to simply invest or trade?
Investment goals, available time, allocated capital, personality and overall portfolio design are factors to determine if it’s better to invest or trade.
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Growth Vs Income
Are you investing for growth or income? If growth is your objective, then investing makes more sense. On the other hand, if you’re looking for income from short term option trades, such as credit spreads, you may want to consider option trading.
Does it Take More Time to Invest or Trade?
Investing is an occasional activity. Remember, however, to be a successful trader, it takes dedication and discipline. So before jumping in, consider your day-to-day schedule.
Many traders are retirees who enjoy the daily mental stimulation of trading, and thus, end up spending hours watching the market. This isn’t necessary. In fact, some of the best traders in the Power Cycle Trading Club have shut down their computer after reaching their daily goal by 9:30 am.
Is it Better to Invest or Trade if You Have a Full-Time Job?
Plenty of traders have full-time jobs. The key is free time. If you have young children, you may find it difficult to study trading material on a Sunday afternoon, for example.
However, if you can allocate a few hours per week, it’s more than worth it in the long run. Many of our trading club members work full time.
Trader Vs Investor Personality
If your personality is such that you find it difficult to detach from your emotions when it comes to your money, you’ll probably be happier investing. Detaching from emotions when trading is an important factor for successful trading.
In general, traders tend to be more intense than most people.
Over the years of running the Power Cycle Trading Club, I’ve noticed that trading tends to attract doctors and engineers. In fact, we have had a number of emergency room doctors given their intense personality and flexible schedule
How Long Does It Take to Learn How to Invest?
A much easier task, learning to invest is quite simple. You can create a traditional 60/40 stock/bond portfolio in minutes. And using ETFs reduces research because they diversify stock-specific risk. However, this strategy replicates a ‘beta’ portfolio and it won’t allow you to outperform the market benchmarks.
How Long Does It Take to Learn How to Trade?
Learning to trade requires a lot more effort than simply learning how to invest. You need to familiarize yourself with trading terminology, research opportunities, identify technical trends and learn trading strategies. However, the more time you put in, the sharper your skills, and the more likely you are to outperform.
Is It Better to Invest or Trade With Low Capital?
If you have a small portfolio, trading is still a option. In fact, options trading specifically allows you to use leverage to control positions with less capital.
In the past, trading with small sums of money was a recipe for disaster. But since U.S. brokerages now offer commission-free trading, you can enter/exit small positions without taking a hit to your bottom line for fees.
Is it Better to Invest or Trade To Achieve Your Long Term Goals?
If you’re unsure whether to invest or trade, realize, the two actually complement one another. In fact, I recommend only a portion of investment capital be allocated toward trading.
Investing for the Long Term
When creating a long term portfolio, it’s essential to own a diversified portfolio that will weather all economic conditions.
Such portfolios will likely have positions in assets such as gold in the event of financial crisis, or real estate for protection from high inflation.
How Does Trading Enhance Long Term Performance?
Trading allows for short term positions. And by allocating a portion of your portfolio to option spreads, in particular, it’s possible to significantly increase short term results while limiting risk
Not only this, but out of the money covered calls can be sold weekly or monthly against a core ETF portfolio without increasing risk. And many investors and financial professionals use options to manage portfolio risk.
When you combine such strategies with long term investments, it creates a balanced portfolio that is likely to outperform the average investor.
Do Options Really Belong in a Portfolio?
Absolutely. Options are simply a derivative of the benefits listed above: you participate in the upside, without incurring the downside. Say you want to enter a position but are nervous about the potential risk, option trading allows you to cap losses at amounts that you’re comfortable with.
The methods of option trading I teach use spreads to limit risk. For that reason, they appeal to older, or more risk averse investors like me.
Overall Portfolio Design
Portfolio construction plays an important role in determining whether it is better to invest or trade.
What is Your Risk Tolerance?
If you’re uncomfortable with volatility, it’s probably better to invest than trade. Investing is a smoother ride because you can ignore the day-to-day noise and analyze your performance over a five, 10 or 20 year period.
What Are Your Goals?
Again, while trading takes far more effort than simply investing, you can see the potential growth from someone who does succeed with trading.
Look at the table below:
How Often Do You Make Withdrawals?
Because you need to hold a position until your strategy plays out, trading makes it difficult to plan for consistent withdrawals. If you want your portfolio to generate a certain amount of cash each month, you may want to stick with dividend investing.
Unfortunately, dividend income is very capital intensive and the income low, hence the appeal of options trading. And many stock investors simply start with selling out of the money covered calls which are a hybrid of both investing and trading.
So what’s the verdict? Is it better to invest or trade?
Well, like peanut butter and jelly, we believe the two are actually better together. When you allocate a portion of your portfolio to a core investment strategy, you create a foundation that you can build on over time. Then, if you take an active approach across other areas of your portfolio, you can increase returns by capitalizing on leverage through options with downside risk protection from spreads.
But if you’re still asking is it better to trade or invest, consider paper trading. This will allow you to learn how to trade, and even test out trading without risk.
Disclaimer: Nothing in this post should be construed as personal financial advice.