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Most people want to become rich or at least have the financial means to spend their time as they please. Working for the man can be tiresome decade after decade.
But how do you go about building wealth?
The financial markets offer two options:
- Short-term trading, or
- Long-term investing
Let’s look at how these two forms differ and the probabilities for success:
Short-term trading
This is what most people dream about: to make a killing in a short period of time. Unfortunately, it’s not very likely and it involves a big risk of losing your capital. The fact is that most traders lose money.
Why do most traders lose money?
The main reason is that the markets in the short-term function like a zero-sum game. What some traders lose, other wins. Even in the stock market, it’s like this. To become a successful and robust trader you need to understand the ecology of the markets. Are you the prey or the predator? No one enters a poker table believing all players will win. But when it comes to trading, most people are full of optimism on how to make money in a short period of time.
The lure of trading is that it’s scalable, ie. trading can turn over your capital many times per month and thus compound the returns in a short period of time. Big players can’t scale their return in the short run because of their size and assets under management, while an individual trader can do that.
Trading also suffers from survivorship bias. We see the winners and the losers. As scale increases, so does the survivorship bias. We rarely hear about those who fail.
Another source of failure is the lack of quantified strategies. In order to make money, you need to backtest a lot of ideas. Backtesting involves making hypotheses about trading strategies and testing those ideas on historical data. Those strategies which work can then be traded via software that automates your strategies. But this requires work and dedication, and most traders want a shortcut. But by taking shortcuts you will never make it as a trader.
If you’re conservative, invest for the long-term
In contrast to short-term trading, long-term investing is not a zero-sum game. Public companies overall make substantial profits and the central banks keep on printing more money. Thus, you have two tailwinds you miss as a short-term trader. Shareholders as a group become wealthier via both dividends and capital appreciation.
The downside of long-term investing is of course that you can’t get rich quickly. However, the chances that you will build wealth are high if you save regularly and over at least two decades.
How do you invest for the long-term? You can simply buy a portfolio of mutual funds and ETFs. Women do this better than men, and they have better returns. Women are not trying to be smart. Women save monthly in a basket of funds and simply forget about it. The less you do, the more likely you are to build wealth.
If you still want to manage the stock-picking yourself, you need to make sure you are investing rationally. But stock picking is difficult because the median stock doesn’t perform well. Returns are skewed to the very few stocks that have astronomical returns, like for example Apple, Samsung, and Coca-cola. But for each of those companies, there are ten that can’t beat the return of Treasury bills.
Conclusion:
Do you have the skills and dedication to make money by short-term trading? If not, go for the conservative bet of long-term investing. Don’t try to be smart, make sure you are well within your circle of competence before you invest.
