This is why some people trade – rather than invest
“Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.”This quote from American economist Paul> READ MORE
“Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.”This quote from American economist Paul> READ MORE
There are plenty of great reasons to own residential real estate – you need a place to live, it’s cheap to borrow money, you get a tax break, and you pay your> READ MORE
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and> READ MORE
To create wealth from investing, you need time, money and a positive rate of return. But maybe not in the combination that Personal Finance 101 suggests. It’s> READ MORE
“Investing should be like watching paint dry or watching grass grow. If you want excitement… go to Las Vegas.”
This quote from American economist Paul Samuelson sums up the difference between investing and trading – investing is for the patient… trading is for those who want more excitement as they search for profits.
Any kind of investable asset, whether it’s individual stocks, stock index ETFs, bonds, commodities or foreign exchange, can be held as a long-term investment or traded for short-term profit. The major difference has to do with how long you hold on to the asset.
Traders will buy an asset and hold it anywhere from a few seconds to a few weeks. Over the last decade or so, and thanks to the exponential growth in computing power, a growing number of traders – called high-frequency traders – hold positions for only fractions of a second. Some of these traders even make use of algorithms to automate their trades.
All types of traders have one main objective – to make short-term gains on an investment, then sell it and move on to the next idea.
Different types of trading strategies
Some are momentum traders who look for assets that are making a major move up or down and have a large number of shares trading hands, or high trading volume. They hope the momentum will continue, and they hold the asset until the price reaches a pre-set level – which can take minutes or an entire trading day.
Technical traders look for patterns or trends in stock, bond, index or currency charts. They then make trades based on what those same patterns have done in the past. They may not know anything about the asset they’re buying or selling. Their decision is only based on what the chart looks like.
The patterns may have names like a “double-bottom,” a “V-reversal,” a “head and shoulders top” or a “rounding bottom.”
Day traders are often technical traders – they may look at various charts and indicators before the markets open in the morning. They’ll then make trades throughout the day to try and profit from how they hope the chart will look later in the day.
Other technical traders will hold an investment for several days or several months. Investors will also use technical research to make long-term investment decisions, but they usually base the decision on long-term charts that show longer-term patterns, not just on what happened the day or month before.
There are also fundamental traders. They base their buy and sell decisions on an asset’s fundamentals – things like earnings, profits and debt levels. The short-term fundamental trader may buy or sell a stock based on what an upcoming company earnings report will say or an anticipated acquisition.
Since a change in company fundamentals can take time to significantly affect a stock price (although a surprise change in fundamentals, like when a company doesn’t make as much money as analysts expected, will have an immediate affect on the share price) fundamental traders often hold a position for several days or weeks.
Trading isn’t for everybody
Being a short-term, active trader can be a lot of work and very stressful. We’ve known quite a few bright people who thought they would do some day trading in the morning, make $1000 by noon and take the rest of the day off. But they soon discover that doing that day after day is not that simple – and you can just as easily lose $1000 by noon if you’re on the wrong side of a trade.
That said, many investors who do make a living as traders – but they know what they’re getting into. And that being a successful trader takes more hard work than luck.
Successful traders have three things in common: they choose one short-term trading strategy (like momentum, technical or fundamental, mentioned above) and stick with it, they take a disciplined approach… and they have nerves of steel.
Three keys to disciplined trading
A disciplined approach to trading involves the right mix of assets and knowing how to set your position size and stop-loss levels.
Many would-be traders put a lot of time into researching what stock to buy. But they hardly give any thought to how many shares they should purchase. Knowing your optimal position size is vital to a well-thought out investment strategy. The amount to buy should be determined, not by how much money you want to make, but how much money you can handle losing.
To help determine your position size, you also need to know your stop-loss levels. A stop-loss, or trailing stop, reflects the most amount of money you’re comfortable losing on an investment. So, if you don’t want to lose more than 25 percent of your position on a stock, you set your stop-loss price at 25 percent below the price you paid for the stock. So, if you paid $20/ share, your stop-loss level would be $15 ($20 – 25%).
As the share price moves higher, and you now don’t want to lose more than 25 percent based on the new higher price, you would establish a trailing stop level. So, if that $20 stock has moved up to $25, your trailing stop level would be 25 percent below that – or $18.75 ($25 – 25%). If the price goes to $30, your trailing stop would be $22.50, and so forth.
Now, you can use your stop-loss target to figure out your position size.
Let’s say you’re buying the $20 stock and you couldn’t handle it if the share price dropped below $17. So, $17 would be your stop-loss level.
Now, consider how much of a paper loss (that is, how much it’s gone down on paper, before you crystallize the loss by selling the position) you can handle. With a $100,000 portfolio, you may feel that a $2000 loss will make you nervous. So, simply divide $2000 by that $3 per share loss you decided you could tolerate ($20 – $17 = $3), and you get your position size. In this case, that would be 667 shares.
Here’s the basic formula (this is just one out of dozens available) and a table to illustrate:
(Maximum $ Risk)/ (Current Stock Price – Stop Price) = Position Size
Asset allocation and risk management
The other part of being a disciplined trader is to know what asset allocation is best for you. Asset allocation refers to the mix of stocks, bonds, cash and other assets in your portfolio. Some say asset allocation is the number one factor affecting investment returns.
For instance, it’s a terrible idea to use all your savings to “play the market” as a trader. The prudent thing to do would be to just use a portion of your overall portfolio to trade – and leave the rest as a mix of good long-term investments, like dividend paying stocks, bonds, cash and some gold.
For the portion you do want to use to trade with, make sure you spread your exposure around a few different sectors. For example, you probably wouldn’t want to just trade energy company shares or make short-term foreign currency trades. Instead, get familiar with a few different sectors so you can make informed trades in any of them. That way, if one sector tanks your entire trading portfolio won’t go down the drain.
And even if it does, because you’ve “diversified your assets” by having the rest of your portfolio in long-term investments, it will be a little less painful.
This article was sponsored by IG. All views expressed in the article are the independent opinion of Truewealth Publishing.
There are plenty of great reasons to own residential real estate – you need a place to live, it’s cheap to borrow money, you get a tax break, and you pay your own mortgage instead of someone else’s.
But there are also bad reasons to own real estate. They’re misleading and deceiving and can lead to life-defining bad decisions. Here are two of them.
1. “There’s no better way to get rich than real estate.”
Dozens of “buy real estate today with nothing down and own twenty apartments tomorrow” seminars will tell you this. And real estate allows for leverage (that is, borrowing) that can amplify your returns (as well as your risk). Some countries offer big tax incentives for real estate buyers.
But as we wrote a few weeks ago, a house or apartment often generates returns that are lower than those of the stock market. Since 1975, stock market returns for the S&P 500 have far outstripped those of real estate. Hong Kong property similarly underperformed the Hang Seng. Only in Singapore did residential real estate appreciate more than the stock market over the long term.
So in fact there is another, better way to get rich besides real estate. It’s called the stock market.
2. “I love collecting rent every month”
Yes, collecting rental checks is nice. But you can earn potentially higher monthly payments – without all the headaches of being a landlord.
The table below shows gross rental yields for various residential real estate markets. Some of them look quite attractive… until you realise these are before maintenance fees, ongoing expenses and taxes. Once fees and taxes are factored in, some of these yields get pretty close to zero. (Please note that this is national data – local data can of course vary considerably.)
Another way to earn a steady monthly income is by investing in dividend paying stocks, bonds or REITs (real estate investment trusts). You have to pay taxes on that income as well, but depending on where you live, it can be a much lower tax bracket than rental income.
There are also no maintenance fees, no late-night clogged-toilet calls to take care of, or “the power went out” texts to disturb you. And it’s a lot easier to sell a stock than it is to sell a rental property.
As you can see below, you can often earn higher yields from these investments than from being a landlord (except bonds at the moment).
The best reason to own real estate today is for diversification – to diversify your income and assets. But real estate isn’t the sure path to riches some claim it to be.
In many parts of the world – depending on the period and place – buying a house or flat has the reputation of being a one-way ticket to wealth. Buy, hold, and be rich.
That’s worked for some generations, in some countries – including in much of Asia. But residential real estate’s reputation in many parts of the world as the ultimate wealth creator is often just wrong. In many markets, stocks do a lot better.
There are plenty of good reasons to own residential real estate. You need someplace to live, and you get tired of paying rent. You can borrow money for almost nothing. You can use your retirement money for a down payment. You saw your parents and grandparents grow rich by buying real estate when they were young. You like the tax advantages (in some countries) of owning real estate. You like cashing the checks that your tenants send you.
But owning a house or apartment, or several of them, often generates returns that are lower than those of the stock market. The chart below shows the long-term returns for the Singapore, Hong Kong and U.S. housing and stock markets. (Stock market results do not include dividends, and housing prices are nominal returns.)
Stock Market vs. Real Estate (R.E.) Performance
The U.S. and Hong Kong stock markets win hands down when compared to house prices over time. It’s only in Singapore where owning a house instead of stocks has made more money.
The U.S. stock market rules
For the U.S. market, the results aren’t even close. The S&P 500 has averaged an 8 percent annual return since 1975. U.S. house prices have earned just 4.8 percent a year since 1975. In fact, over nearly every decade, the S&P 500 does better than housing.
The only decade when housing did better encompassed the recent housing bubble, from 2000 to 2010. Even accounting for the sharp decline in the last two years of that period, U.S. housing prices still outperformed the S&P 500 for the decade.
So far this decade, the U.S. stock market is ahead once again. And for the past 40 years, it would have earned you almost 4 times as much as U.S. residential real estate.
Hong Kong – stocks win again
Hong Kong house prices have done much better than U.S. housing prices (Hong Kong house price data since 1980). But since 1980, Hong Kong real estate (up about 1,500 percent over the period) has trailed Hong Kong’s Hang Seng stock index (up nearly 2,700 percent).
And only since 2000 have Hong Kong house prices started to catch up to stock market performance. During the 1980s and 1990s the stock market was unbeatable. Since 2000, Hong Kong housing has performed much better.
But residential real estate has beaten stocks in Singapore
Since 1980, Singapore real estate has generated better returns than Singapore-listed stocks. It’s the exception in the three markets we looked at.
Singapore house prices have averaged 6 percent annual returns since 1980; stocks have only returned 5 percent a year (based on data from Datastream and the Straits Times Index). But stocks did better than housing in the 1980s and the 2000s. It was Singapore’s hot property market in the 1990s that made the difference. But so far this decade, neither house prices nor stock prices have done well.
Real estate should be part of a well-diversified portfolio. But not at the cost of investing in shares.
To create wealth from investing, you need time, money and a positive rate of return. But maybe not in the combination that Personal Finance 101 suggests. It’s never too late to start saving – and even if you’re starting late, you could be in better shape than you think.
Two hypothetical – and simplified – savers, Lee and Ann, will show how.
Lee – the slow, steady saver
The day Lee is born, his parents start to invest $100 for him every month in a special investment account that yields 5 percent (during a period when zero and negative interest rates are as foreign as chicken rice on Mars). For 60 years, they make a deposit every month, and interest builds every year.
So at the end of 60 years, Lee’s parents invested a total of $72,000 ($1,200/year). Thanks to the magic of compounding, when the interest earned is reinvested and starts earning more interest, Lee’s account balance after 60 years (he never touches it) stands at $424,300.
During those 60 years, Lee takes the scenic route through life. He doesn’t save a penny. On the day he starts his seventh decade, he’s the proud owner of absolutely nothing. But he also owes nothing. So his net worth is solely the account that his parents started for him when he was born.
This is a (very) simplified version of one of the foundations of personal finance: Start saving early, even if it isn’t very much. Skip the cappuccino, put the kids in bargain basement castoffs instead of Nikes, and keep your iPhone 4 in a world of iPhone 6’s. Take a short flight to Phuket or Orlando (depending on where you are), rather than a luxury cruise to Tierra del Fuego.
But a life of sacrifice doesn’t suit everyone. More importantly, it doesn’t have to be that way. For many people, the structure of lifetime earnings is very different. Compounding works, especially over longer periods of time. But it’s not the only way to build wealth.
Ann starts late – but makes it up
If you know early on that you’re going to take Lee’s career route, you’d better start saving early. But many people are more like Ann.
Ann’s parents didn’t open an account for her at birth. They bring her up and put her through school and let her figure out how to earn a living. So Ann gets a job and rises through the ranks.
Ann isn’t a good saver. She fancies Jimmy Choo and Kate Spade, and bright cars that roar. She gets a puffy coffee beverage every day and doesn’t even learn how to use her own stove. By middle age, she owns nothing – and owes nothing. She’s like Lee, but without a parental safety net.
Unlike Lee, Ann has been building her “personal equity.” She has a career and her earnings are rising every year. On her 45th birthday, she changes course and resolves to save $20,000 every year until she’s 60 (totalling 15 years of savings). She also earns a 5 percent return on her capital, compounded annually.
Ann banks a total of $300,000, and thanks to compounding, by the time Ann is 60, she has a net worth of $431,500, very close to Lee. Ann starts four and a half decades after Lee, so the power of compounding has much less time to work for her. But she saves a lot more. And Lee and Ann get to about the same financial place by the time each of them turns 60.
Ann isn’t so unusual
Ann’s scenario happens all the time. Saving when you’re younger is difficult for many people. Eventually, your kids leave home, or finish university, and suddenly you have more money to spend. Or the flat or house is paid off and the monthly mortgage bill vanishes. Or an aunt or a parent passes and leaves a small bundle. (In Hong Kong, 70% of adults expect to leave an inheritance and the average amount left behind is US$146,000.)
Or you get a raise at work, and decide to put off the five-star holiday or the new car or the bigger house in favour of starting a nest egg. Whether it’s a lump sum or an accelerated savings plan, it can save the Anns of the world.
In Asia, many entrepreneurs spend decades building up their businesses and paying themselves very little so that they can reinvest in their business. When the business is ready to be sold or passed on, the founders will be older – and will suddenly have a lot of money on their hands.
It’s never too late to start saving. Saving a big chunk of money later in life is a realistic scenario for a lot of people – maybe more realistic than saving a regular amount every month starting from a young age. If the amount you’re able to save later on is large enough, it can compensate for less time to compound (and a lower savings rate).
If you’re middle-aged and haven’t really had a chance to save much yet, you can start right away and still retire comfortably. It’s never too late to start creating wealth.
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