March 18, 2021
The collision of commission-free stock trading on smartphone apps with a lot of bored people stuck at home during the pandemic has me worried.
The ease of being able to jump in (and out) of stocks with a few clicks has many of you interested in becoming stock traders. And your trades are being driven by what you read on message boards or see someone tweet about.
I am not going to tell you to not trade. But I am going to insist that you understand there is a very big difference between trading and investing. Trading is far riskier than investing. Again, that’s your decision to make. But if you are serious about building long-term wealth, trading is a lousy way to go about it.
Investing: Boring is Beautiful
Investing is about working toward a long-term goal. Saving in a workplace 401(k) or 403(b) is investing. You contribute a portion of each paycheck into your retirement account, where you likely own a few well-diversified mutual funds. You can do the same with an Individual Retirement Account (IRA) that you automatically contribute to via direct deposits from your checking account.
Boring? Ab-so-lute-ly! But boring is smart. Without having to chase after trends, or pay attention to the news, a consistent saving strategy that invests in diversified low-cost index mutual funds or ETFs is going to deliver what matters: retirement income.
We’ve had three bear markets since 2000 (and in 2018, a 19% decline fell just short of being an official bear market.) Plenty of down markets, right? But if you just kept saving you have done well. The S&P 500 has returned nearly 300% in the 21st Century. By comparison, money parked in a cash savings account is up about 40%.
Trading: The Adrenaline Rush
Buying individual stocks with an eye on a quick “win” is not investing. It is trading. The recent mania around GameStop stock is just the latest example of the risks involved. At one point earlier this year, the stock rocketed from under $20 per share to over $480 as it became the most talked about stock among individual investors, who for a brief period were outwitting Wall St. investors who had bet the stock’s value would fall.
Yet if you didn’t get in super early, before GameStop headlines really took hold, you likely lost plenty of money. On January 25th, the day before the stock started to rocket it cost about $77 a share. Then it had that crazy ride to $483 a share. But that lasted for less than one trading day. About a week later the stock was back down to $53, and kept falling for a few more weeks, to a low of around $40 a share. And in early March the wild ride resumed, with the stock price rising above $200 a share. Exciting? Fun? Sure. Profitable? Not for many investors who piled in during the first round of GameStop mania. (A recent academic study conducted before the GameStop episode, looked at stocks that became very popular on the Robinhood trading app. They found that on average, after a stock become a Robinhood mega-darling, it lost an average of 20% in the following month.)
Don’t Rush In
Again, I am not going to tell you to avoid trading. I do have some guidelines.