“Of course I’m an investor… I’ve got a 401k which I use to invest in mutual funds” he said. I had to shake my head. He had one of the most basic, yet most common misconceptions out there; confusing investing with trading.
Many people think they are investing, while in fact they are trading. Telling the difference is not that difficult with a little help from a trip to your local farm:
Trader – A trader is similar to a rancher who raises cattle but then kills them and sells the meat. In order for them to realize a profit, they need to kill their investment. Trading has its value when you have the knowledge and skills to manage the risk to create greater profit in a shorter period.
Thus a trader is someone who buys something with the intention to sell it at a later point in time at a higher price, and therefore at a profit. Examples of this include:
- Flipping real estate: Buying a property only to try and sell it in a certain period of time at a higher price
- Buying and Selling Stocks, Mutual Funds, or Securities: Most people call this investing, but it is not! This can be a great way to make money if you know what you are doing, but it is not investing, it is trading.
- Buying and selling Gold, Silver, Pnesomatic coins, artwork
- Buying a private business or franchise, with the expectation of selling it for a profit.
Investor – An investor is similar to a dairy farmer. Instead of killing their cattle, they milk their cows and sell the milk day in and day out. They do not sell or kill their cows unless they don’t produce milk, or because they are now too old.
Thus an investor is someone who invests money for the cash flow that the investment provides. This can be paid at different intervals, but the investment is purchased is not for the sale, but for the cash flow that comes in. Examples of this include:
- Buying a piece of real estate because the rental income is greater than the expenses, thus providing monthly income.
- Buying stocks for the dividends
- Buying stocks and selling monthly call options against the stock to bring in monthly income
- Buying a private business or franchise for the monthly income it provides from the profits of the business.
An important distinction is that you cannot get out of the rat race by only trading. If you have to kill your “investments” in order to have money to live, then you get to constantly worry about the possibility of outliving your resources. If you can milk your investments over and over again, living off of that income, then you are truly out of the rat race.
I’m not saying to only invest and not trade. Both trading and investing are important techniques to learn and can accelerate your escape from the rat race. In fact, trading can be a great way to generate a large sum of capital in a short period of time which you can then funnel into investments. My point is to make sure you understand whether you are investing or trading, and why you want to balance your portfolio between investments and trading to escape from the rat race faster.
Live your life. Choose freedom.