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Long-Term Investing vs. Short-Term Trading

You’ll hear financial pundits say that buy and hold investing is dead or encourage you to bounce in and out of stocks as if many that have come before have been successful at doing so. The reality is that being successful at short-term trading is extremely low to impossible. Even if you could beat the market in absolute return, after you deduct trading fees and taxes, your return will diminish significantly. A buy and hold investor and a trader who both earn 10% before trading fees and taxes will have much different returns after them. The trader will just have worked a lot harder during the year constantly looking at headlines and charts. The buy and hold investor will have done his or her work upfront and have rest assured that his or her investment was a good long-term holding with good long-term economics.

Stock Market Trading Floor

Long-term investing is essentially business investing. If you’re in it for the long-term, think of buying a stock as buying a part of a business (because it is) and not a piece of paper or lottery ticket. In the long run, the best businesses will outperform and the subpar businesses will underperform. It’s as simple as that. Coca-Cola, Johnson & Johnson, General Mills, General Electric – these companies have been around for a long time – and they all have had their stocks rise, fall, go sideways, downgraded, and upgraded throughout their histories. Yet, their stock prices have all risen in the long-term because they reflect the essential values of their businesses. In the short-term, anything can happen.

Echoing Benjamin Graham, the market is a voting machine in the short-term and a weighing machine in the long-term. Stocks can get bid up to astronomical levels or fall to ridiculous levels in the short-term just because their underlying businesses are in a “revolutionary industry” or because they’re expected to make a few pennies less on a per share basis. Those in the market are essentially “voting” on what’s popular and what’s not popular in the short-term. In the long run, however, the stock’s true value or “weight” is reflected in its price. The market will reflect psychology in the short-term with stock prices reflecting investor emotions more than economics or value. In the long run, however, stock prices will be more in line with underlying value and reflect the economics of the underlying business.

Going back to trading fees and taxes, sometimes referred to as the frictional costs of trading, those costs will eat into any profits you can make in the short-term bouncing in and out of stocks. Maybe you get lucky on one or two stocks, but the odds are insurmountably not in your favor. Even the best fund managers, whether running relatively constricted mutual funds or free wielding hedge funds, fail to beat the market. Such funds even get to spread the costs of trading over millions or billions of dollars and still can’t overcome the market. Although taxes may vary depending on what tax bracket you’re in, it is a general rule that short-term gains are taxed more heavily than long-term ones – making it even harder to make more money trading than investing.

Thus, keep a long-term mindset and remember that when you buy a stock, you’re buying a business and not a lottery ticket. The stock price may go in all different directions in the short-term. In the long run, though, the stock price will reflect the true value of the underlying business.

- Andrew Sebastian

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