Trading and Investing. We hear these terms a lot. After all, they go hand-in-hand with finance. While we might think of them as synonyms, there is an essential difference between the two. Understanding this distinction is crucial for anyone wanting to put their money to work for their future goals. Let’s break it down.
We often use trading and investing interchangeably. It makes sense: we can’t invest without making a trade. However, similar, there are key differences.
Let’s quickly define both terms.
Trading
Trading is the exchange of one item for another. We can make trades with almost anything, and as humans, we’ve been doing so for eons.
Bartering is the exchange of one good for another. Clothes swaps were people trade different garments between them is a great example.
More practically, we exchange money for goods and services.
Money acts as a common denominator for our economy. It’s a universal medium that allows us to value practically everything in our world (for better or for worse).
Whenever we make purchases, we’re trading our cash for something in return.
Investing
Investing is the act of spending money on an item to make a profit in the future. The future can be anywhere from later today to 100 years from now (seriously).
In other words, we forego the short term comfort of having some cash right now in expectation of having more money later.
So what’s the difference?
In finance, we talk a lot about trading. When we make investments, we start by trading money for a financial product we think will increase in value. These could be stocks, bonds, funds, commodities, real estate, and more.
Further, people trade stocks all the time on stock exchanges. Since we associate stocks with investing, we’re tempted to use the two terms freely. Doing so is a misnomer.
People who make frequent trades are what are known as “active traders.” These folks aim to make money by quickly buying and selling financial products. They aren’t interested in the income like dividends they generate. Instead, they look for pricing differences to exploit.
Yes, you could say that by holding onto an item over the short term in anticipation that it increases in value is investing.
However, when we talk about Investing in a financial planning sense, we mean holding onto a financial product for a long time, anticipating a profoundly higher value later on.
Most governments tend to agree with this assessment. Around the world, tax authorities make a difference between the two.
A capital gain is the profit you (hopefully) make on an investment between the time you buy it and sell it.
Governments tend to tax these separately depending on how long an investor holds them.
- A short-term capital gain is one made within a short period, often under one year.
- A long-term capital gain is one made over a long period, usually over one year.
Short-term capital gains get taxed at a higher rate than long-term ones. Governments reason that if someone has lots of short-term gains, then this person generates income through lots of trading. Therefore, they assume that the person is more dependent on that money for their daily lives.
Put together, trading as we picture it, and long-term investing are two very different acts.
Why it matters to people investing in their future (including those living abroad)
If you want to save for your future, knowing the difference between trading and investing is crucial.
Trading costs money. The more trades you make, the more fees you pay to a broker or a bank. Over the long run, those fees add up. Additionally, short-term capital gains taxes pile up quickly.
Most everyone is better off passively investing over the long run instead of short-term trading.
Second, making short-term trades increases risk. No one can predict the market. If an investor gets his timing wrong, his losses could be significant.
Finally, individuals lack the market access and resources of professional traders. Trading companies can place large orders across the world at nearly the speed of light. These firms also trade in large quantities, giving them an advantage over individuals who trade small amounts of shares.
Most everyone is better off passively investing over the long run instead of short-term trading.
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Passive investment strategies aim to minimize trading costs and maximize overall returns.
To do so, investors make periodic investments, trading cash for funds. These funds invest in a basket of stocks, bonds, and real estate.
Over the long term, the value of these funds tends to increase. Since the individual holds into their investments instead of periodically trading them, they reap significant gains.
For people living abroad, this is no exception. Like everyone, expats, digital nomads, and remote workers have plans for their money. Even if these future goals are in far-flung places, the concept remains the same: trading increases costs and risks, with no superior upside.
It’s complicated knowing which investments to make and how to manage them. We recommend that anyone serious about long-term investing speak to an investment advisor. These professionals work with individuals to find the best investments and strategies for their needs.
After all, it’s your money and your time. Trading some of it for good advice is an excellent investment in your future.
Abroaden is a company for expats, digital nomads and other world citizens looking for low-cost and transparent financial advice and investment management.
Note that this article is for information and educational purposes only. It does not constitute financial advice.
