Traders versus Investors — Who Does Better?
Kurt Brouwer October 23rd, 2007
A great deal of Wall Street’s brainpower is devoted to gaining an edge in short-term trading. If you read brokerage house research reports, they are frequently focused on what stocks are picking up momentum and thus should be good buys — over the short-term. On the other hand, there are those investors who buy and hold for the long haul.
In this post from his blog, Kudlow’s Money Politic$, Larry Kudlow talks about traders versus investors.
‘…Last night I asked Jeremy Siegel, Wharton Finance professor and author of “Stocks for the Long Run,” the following question: Who does better, long-term investors or traders? That’s really the key question. Siegel said it’s a no-brainer—definitely long term investors. He conceded that there’s a very tiny few who can buck the trend and succeed in the short term game. But on the whole, it’s no contest, you want to be a long-term investor.
I posed the same question to Trend Macro CIO Don Luskin. Here’s what he had to say: “There’s no question about it. The great myth of trading is that it’s the very, very few survivors in the trading game who show their face to the public, who come on CNBC. What you don’t see…are [the] 10,000 who are driving cabs and flipping burgers somewhere.”…’
Don Luskin kind of mangled his comment, but his point is a good one. When we hear about someone who was successful in short-term trading what we do not hear about are the thousands of traders who lost money using similar strategies. One analogy to consider has to do with coin tosses. If one million people paired up and tossed a quarter, then half would call it correctly and half would fail. If we repeated that process, after 20 tosses, we would have one winner who had called the toss correctly 20 times. No doubt this hero would get rich off promoting his or her ’system’ for calling tosses correctly with advertising that might go like this, “I made a fortune with my patented wrist flip and you can too!”
Many people might actually buy this champion coin tosser’s wrist flip ’system’ even though, as we saw, the champion’s success was really a matter of chance. Similarly, we often hear about trading systems that are ‘proven’ winners and can help you make lots of money, if only you’ll buy the book, newsletter, DVD etc. In my experience, the only people who reliably make money from these trading systems are the ones selling them.
Fortunately, there is a better way. Kudlow’s post continues [emphasis added]:
‘…It’s quite simple actually. If you want to fatten your wallet, and if you want to sleep better at night, then you need to own a piece of the American rock. Own it for the long run. Our dynamic system of free market capitalism works. It’s still the safest, surest, most profitable investment strategy out there…’
There are different ways to own a piece of the American ‘rock’ as Kudlow calls it. You could research and purchase a diversified portfolio of stocks, you could buy a stock index fund or exchange-traded fund or you could buy an actively-managed stock fund. Assuming you made a reasonably good purchase, the key determinant of your success is what you do afterwards. Do you hold on for a number of years or do you try to trade in and out of the market or in and out of a given stock? Is it possible to make money trading stocks or mutual funds or exchange traded funds? Certainly. However, successful trading requires discipline, excellent timing, good nerves and a fair amount of luck.
A much easier strategy is to buy high quality stock mutual funds and simply hold on as the economy marches on. In our work, we take this approach by investing in a diversified portfolio of high quality mutual funds. We certainly watch them closely and occasionally make changes, but our goal is to invest in funds we can hold for many years.
So, who does better, traders or investors? In my experience, investing is far more predictable and profitable than trading.
- Investing , Mutual Funds , Personal Finance
- Comments(5)
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Very nice post. I totally agree. Lazy investing all the way…I have better things to follow on a daily basis!
I always go by the old rule - if it’s too good to be true, it isn’t. I like your analogy of the successful trader and the coin toss.
Agreed. I’m of the “set it and forget it” school. However, I don’t see why actively managed funds are better than index funds. The former are more expensive, and most funds fail to beat the market OVER THE LONG HAUL.
Steve–One important point to understand is that investors frequently fail to achieve the return of the underlying fund in which they’ve invested–whether it is active or passive. For example, consider someone who invested in the S&P 500 in 1999 near the peak and then got discouraged and sold out near the bottom in 2002.
We use many actively-managed mutual funds, but that does not mean you should. Having a disciplined strategy you can stick to is more important than whether or not you use a passive index fund or an actively-managed fund.
Carnival of Everything Finance: # 6 Edition
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