Monday, 8 September 2014

Investing Vs Trading - A False Dichotomy

Recently, have you run across a growing number of references to the virtues of being a "committed" investor instead of a "speculative" trader? I know that I have.

Here is a typical statement: "You cannot succeed if you trade a lot. You can only succeed by being an actual investor. You must realize that by owning a share of stock, you are in fact a partial owner of a real business. No business owner wants skittish investors. Corporations want committed, interested investors who are going to look to the long term, support the company through thick and thin, and not sell the stock at the first sign of short-term problems or bumps in the road."

Well. As they say in The Godfather, "It's business, not personal." Let's look at a few facts.

First, some of the points in the statement above are true. If you buy a share of stock, you are, in fact, part owner of the business. Corporations generally would prefer shareholders with a long-term point of view. A long-term view does look right over and beyond mere bumps in the road.

But other ideas are false or misleading. For one thing, many active traders are, in fact successful. You can succeed or fail if you trade stocks. It is probably true that the majority of hyperactive traders do not beat the market, but that simply means they have faulty strategies, or that they execute their strategies poorly, or both. Many traders do beat the market, handily and consistently. Poor traders are often people who have insufficient knowledge, don't do their homework, do not have a strategic approach that suits their goals and personality, and are impatient.

The "trading versus investing" dichotomy sets up a false premise: that there are only two ways to participate in the market, by being a "buy and holder" or by being a "trader." The word "trader" often carries a negative connotation while "investor" has a halo.

Where does one cross the line from being a "trader" to an "investor"? Must you only buy--but never sell--to be an investor? If I turn my portfolio over ten percent per year, does that make me a trader? Twenty percent? One hundred percent? If I buy a stock and then sell it ten days later because its CEO just got indicted, does that make me a trader rather than an investor? Or does it make me a smarter investor? If I hold most of my stocks at least a year, does that make me an investor? Three years? Five years?

The fact is, there are places all along the spectrum between the extremes of "buy-and-holder" to "trader." It does not advance the analysis to force any person into one category or the other. And self-defeating decisions are not limited to traders. Sometimes the most reckless thing you can do with an investment is hold onto it. The bubble proved that.

To me, the most sensible approach to being an investor is to establish a set of rules and principles that are intelligent and fact-based, and then execute them according to plan. Every so often, take a step back to re-examine your goals and strategies to see whether they still make sense. The bottom line is to take a long-term view, but recognize that will sometimes lead to short-term activity. There is no logical contradiction in that.

The Sensible Stock Investor holds some stocks for a relatively short time (measured in weeks) and other stocks for years. What label should be put on that? I would suggest a label like "sensible." Or "buy-to-hold," meaning that the intent when purchasing a stock is to hold it for a long time, but that you will sell it when it stops achieving the goals you set for it.

From the corporation's point of view, what I (as a small investor) do with my shares of stock is irrelevant. Owning a tiny share of a business is not the same thing as having a controlling interest in the business. If I buy 100 shares of AT&T, I own .00016% of the business. My ownership of those shares gives me zero control over how the business is run. I don't have a seat on the Board, and management doesn't listen to anything I say.

Now if I were just starting out my own business, and I had five angel investors, of course I would want them to be committed to my business, stand behind me, and not pull their investments out at the first sign of trouble. They would want me to do well, and they would recognize that the best chance for me to do well is for them to help me.

But with a large public corporation, the trading of their shares does not affect the running or financial foundation of the corporation in the slightest. The corporation got its capital at the IPO, via secondary offerings of its stock, or by borrowing. If you and your neighbor trade the shares back and forth, the corporation isn't affected and shouldn't care. There is nothing morally virtuous about being a buy-and-holder. Trading is morally neutral. The question whether to trade or not is a business decision, pure and simple.

Each party acts in his or her best interest as each perceives it. It is true that many investors who trade a lot, or who react emotionally to short-term "noise" in the market, do worse than others who hold their investments longer. But so what? That does not mean that you have to make those mistakes. At other times, traders do better than buy-and-holders. Neither approach is inherently better than the other.

The fact is, "investing" is the buying of a security. No more and no less. If that security serves my purposes for a long time, I may well hold it for years. But if the security fails to meet my reasonable expectations for it, or if the corporation that issued it screws up and starts to hurt me, I owe no obligation to continue to hold that security. I can sell it and look for a better place for my money. In fact, my fiduciary duty to myself demands that I do so.

By Dave Van Knapp (
The author of two books on stock investing.
The first is "Sensible Stock Investing: How to Pick, Value, and Manage Stocks."

The second is "The Top 40 Dividend Stocks for 2008: How (and Why) to Build a Cash Machine of Dividend Stocks."

Quote for the day

“Knowledge is the theoretical paradigm, the what to do and the why. Skill is the how to do. And desire is the motivation, the want to do. In order to make something a habit in our lives, we have to have all three” - Stephen R. Covey