investing-vs-trading

Investing v/s Trading…

For people who are new to this financial world, these two words might mean the same. But there is a subtle difference if you dig a bit deeper into the exact process these words represent.

Before going into the differences, let me ask you a question. Why do you need to invest/trade? What do you need if you want to invest apart from money?

1) Why you need to invest?

You are not wrong if you think of answers like to create wealth / to generate secondary income/ to be financially free/ to increase your social status by becoming rich etc. But even though you are not interested in all the reasons mentioned here, you still need to invest. Let me tell you why. There is something called “inflation“. Simply defined as “The rise or fall of prices of goods“. If the price of the commodities increases, it means that inflation has increased. If the price of the commodities falls, it means that inflation has relatively decreased It is the job of Central Bank (RBI in India) to keep the inflation in control. Our day job salaries remaining the same and the inflation keeps on increasing year by year, so it is utterly necessary to protect ourselves from inflation. That cannot be done by keeping your hard-earned money in the Savings Bank account. Even the money deposited in Fixed Deposit accounts cannot save you from this inflation beast. So you must let grow your money to take control of this inflation to fulfil your future financial goals. If you want to read more about the need to invest, I recommend you to refer this link http://zerodha.com/varsity/chapter/the-need-to-invest/ .

2) What do you need if you want to invest apart from money?

If you are convinced that there is a necessity to invest your money, then the next question is where should I invest? Here come the terms, which you might already familiar with, “assets and liabilities“. If something keeps money in your pocket at the end of the month, it is an asset, if it takes money out of your pocket at the end of the month, it is a liability (copied from the book Cash Flow Quadrant written by Robert Kiyosaki). Don’t make the definitions of these terms more complex than these. To make it a bit clear, refer the following examples,

examples:-

1) The house that is bought to live with your mortgage loan is not an asset, it is a liability as you need to pay loan installments end of every month and it is not generating money greater than the installments you are paying.

2) The house that is bought with the same loan, but with the intention of giving it to rent which is greater than that of your loan instalment is an asset as it is adding money to your pocket at the end of the month.

That’s it. nothing more complex than that. In the first example, the house is an asset for the bank and is a liability to you.

In the second example, the house is an asset for you and your bank, but it is a liability for your tenants.

We have a very vast asset class to invest. Some of them as follows:

Bonds
Fixed Deposits
Mutual Funds
Stocks
Real Estate etc.
The risk level of the investment depends on the asset class you choose to invest. The greater the risk, the more is the profit potential.

If it clear till now, let’s go into the mainstream of this article. How Investing and Trading differs??

Difference between Investing and Trading-

Please consider this example to understand this difference.

There is a guy named Raju who owns the land and is in need of money. He wants to sell the land if he finds a buyer at a reasonable price. Let us say that land costs Rs.1,00,000. There is another guy named Arjun, who is an investor and has money in his hand. He has a plan of constructing an apartment in that land so that he can earn from the rents paid by the tenants. Arjun is desperately searching for the land to buy so that he can start construction work. There is another guy named Krishna, who thinks that the land price is going to increase in the short term as the demand is high for the land at present. So he buys the land from Raju for Rs.1,00,000 and waits for the right opportunity to sell it for a better rate. When Arjun finds Krishna, there is a chance of making a deal at a particular price, let us say Rs.1,50,000.Now Krishna gets rid of that land taking money as he has made a profit of Rs.50,000 and Arjun will start his business plans soon after the registration is completed.

In the above example, Krishna is a trader. Arjun is an investor. The main difference is, Krishna has an intention to sell the asset when he finds the right opportunity and Arjun wants to keep the asset to extract regular income from it in the future. So, the difference can be simply stated in one line as follows:

“ If an asset is bought with an intention to sell in the near future when the price of the asset appreciates, it is Trading. Trading generates income.”

“If an asset is bought with an intention to keep it forever so that the investor can extract regular income out of it, it is Investing. Investing creates wealth.”

I am a trader and this blog is designed to help the traders who want to create income out of financial assets from short term movements in the price of assets. I just want to make things a bit clear before starting the actual technical aspects of trading. Hope it helps.