What's the difference between trading and investing? Does active trading lead to better returns? If so, should you trade your retirement account? what does it actually mean to be an active day trader? These are all the things that we're going to touch on in this episode of retire once. Hello and welcome, I am Johnathan Rankin, Founder and CEO of Theorem Wealth Management and this is the Retire Once Show, the show designed to help you get to retirement, and most importantly, stay retired.
Being an active trader is a completely different strategy then long-term investing. Now when I mean trader, I don’t mean that stock photo of Einstein reincarnated that every financial news show puts up when referring to the trading floor. In all seriousness, just Google stock market floor trader and he pops up in 1 out of every 3 photos. Most day traders that I've talked to have a goal of trying to beat the market, so they jump in and out of stocks every single day. Investors who are active traders might make decisions based on a number of different factors such as technical indicators like moving averages or as we have seen this year, something as simple as a recommendation on forums like Reddit or Twitter. More often than not, studies have shown that trading decisions are not based on sound research or tested trading methods, but on emotions, and the need for entertainment. I read an interesting statistic that showed trading volume in active trading accounts actually decreases during larger than normal lottery drawings.
When comparing that to long-term investing, long term investors typically focus on their financial goals first. For some, that may be a hard place to start. I have met so many people over the years that started saving because they knew it was what they were supposed to do, but when it came down to identifying a financial goal, it was never something they put much thought into. If you find yourself saving and investing without a clearly defined financial goal, I always recommend asking yourself the question, what is the purpose of this account. By starting with that question, it will help you identify what you are saving for. For example, if you are saving in a 401(k) or IRA, the purpose of that money is likely retirement and from there you can dig into what retirement really looks like so you can determine a well-defined financial goal. Determining a specific financial goal for a retirement account may be a lot easier and straight forward than if you are saving into an after-tax savings account or brokerage account, but that doesn’t mean it is any less important.
Imagine if you told your boss you were going to take two weeks off for a vacation, you pack your luggage and got in the car and just started driving. No plan, do destination, just driving. Most people don’t take vacation like that. Most people spend hours, days and even weeks to plan out all of the little details about their vacation. Yet I would argue that your cumulative savings is likely worth a lot more than your vacations days and yet so many people invest without having an idea of what they are investing for. It’s like walking into the grocery store when you’re hungry, but you haven’t decided what you want to eat. You end up with a basket of stuff that makes no sense. You get home, look in the bag and try to make sense of what was going through my brain. Ok, I have milk, salmon, a frozen pack of curly fries, some Ben and Jerry’s and a fresh baked baguette from the bakery section.
By focusing on your financial goals, you might realize that you don’t want or don’t need the boom or bust affect that can happen when being an active trader. long-term investors generally focus on diversification, and risk-adjusted returns. The purpose of diversification is to help reduce volatility and improve returns on a risk-adjusted basis. During a downturn, a broad-based portfolio generally won’t lose as much as a concentrated allocation could. For example, in 2008, the S&P 500 was down 37%, however if somebody had 50% of their money invested in bonds and 50% in stocks, they would have lost 15.8%(1). Don’t get me wrong, losses are never fun, but a loss like that wouldn’t ruin your long-term financial goals. One of the hardest parts about being a long-term investor is avoiding that feeling of missing out on the high-flying stocks all over the headlines. Being a disciplined and diversified investor can be boring. It’s like the Tim Duncan of investing. You aren’t going to get many highlights or flashy plays, but you will get consistency over a long period of time.
With all that being said, for many investors it comes down to the bottom line.
So, does being an active trader actually lead to higher performance?
Investors often believe that activity impacts success. Day trading can look like an attractive way to make money, but it comes with a lot of risks. Just because someone is more active, does not necessarily mean they are having success. It’s like the way my son cleans his room. He moves a lot of stuff around, he seems busy and then when you go in to check on him you realize that he just moved the mess from one side of the room to the other. In case of day trading success, studies have shown that the general failure rate for day traders is around 95 percent, according to a study from UC Berkley, only about 4.5 percent of day traders are successful, meaning they generate significant profit. If success is defined simply as not losing money, the success rate only climbs to around 6 percent. Other sources put the success rate even lower, at 1 percent. In fact, 80% of all day traders quit within the first two years.(2)
Studies have shown that the average individual investor underperforms a market index by 1.5% per year. Active traders underperform by 6.5% annually.(3)
So, does all of this mean that it is not a good idea to be an active trader?
If you are interested in the markets and enjoy buying and selling stocks, being a trader is not a bad thing. If you like doing it, the goal is to do it in moderation. I like cake, however if every meal was a slice of cake, at some point, it would probably make me pretty unhealthy. I have seen many long-term retirement focused investors start by putting together a detailed retirement plan and allocate a small portion of their asset allocation to an account meant for active trading. Many people refer to these as “play accounts”, maybe it’s just me, but I don’t associate money with playing. That mindset typically will lead to more risk and is meant for Las Vegas. Allocating a portion of one’s stock exposure to an active trading account gives investors the opportunity to fulfill the interest they have in being an active investor, while still focusing on their long-term financial goal.
If you haven’t put together a detailed retirement analysis or just want to make sure that yours is updated and that you are on track, use the link below to schedule time for us to connect. Our team would be happy to put together a complimentary assessment of your retirement to see if you are on track to your financial goals. Thank you for watching, until next time.
Submit questions to the show at Retire@theoremwm.com
- Johnathan Rankin CRPC® CEPA®, Founder & CEO,
- Melissa Rankin - Wealth Management Advisor
- Theorem Wealth Management, Financial Advisor Dallas Texas
- Retire Once Show - 2022 Retirement Podcast Series
1 - http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
2 - Barber, Lee, Odean (2010): Do Day Traders Rationally Learn About Their Ability?
3 - Kumar: Who Gambles In The Stock Market?
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