Investment Strategy

Who wins the race: the investing tortoise or the trading hare?

You’ve probably heard Aesop’s famous fable about the tortoise and the hare. A tortoise challenges a hare to a race. The hare thinks he has an obvious advantage, but is complacent, and takes a nap along the way. The tortoise wins. Broadly speaking, people invest either like tortoises or like hares. Both approaches can work. But, when it comes to private investors, I encourage you to be the tortoise.

First let’s clarify some definitions, at least as I use them.

“Traders” take short-term positions on financial instruments, including stocks and bonds but also more racy areas like currencies, commodities and options.

“Investors” take a longer-term view. Of course, they have to “trade” to get in and out, but trading frequency should be low.

These are alternative approaches that people can take to build their wealth over time, principally in the financial markets. Either can work, but I strongly believe one is much easier for the private individual.

Finance and investing is a big and complex arena. It’s full of theories and jargon. These are very handy for finance professionals looking to extract fat fees and commissions from their customers.

Unfortunately, what’s right for the pros is often dead wrong for private investors. However, there’s usually little distinction made either in investing literature, or in the advice that comes from the mouths of investment advisors.

So what’s involved in being either a trading “hare” or an investing “tortoise”?

The hares are impatient, fidgety, impulsive, and looking for instant results. The tortoises are patient, cautious, persistent, and prepared to wait a while.

Knowing which you are, or which you aspire to be, is essential for any successful investor.

Here’s a summary of some key considerations that I put together:

I’ve already dealt with typical personalities of traders vs. investors. But let me expand on their time horizons, by which I mean how fast they expect to get results.

Traders are people who want results now…or preferably yesterday. Traders measure their results in hours, days, weeks or months.

Investors, on the other hand, are playing a longer game. They’re medium to long term, looking for results over one year, several years, and sometimes decades.

Because of this, traders and investors are attracted to different kinds of typical strategy.

A typical trader strategy is momentum investing, chasing stocks higher just because they’ve been going higher recently. Quite a few are “chartists”, or “technical analysts”, that look for patterns in price charts (human beings are pattern-seeking animals, after all). As soon as the trend breaks, the position is dumped and the trader moves on to the next thing.

A typical investor strategy is value investing, which is looking for cheap, beaten-down stocks in relation to fundamentals (e.g. business growth, dividend yield, valuation). The simple idea: wait until the stock is no longer cheap, and a profit can be taken.

Of course, there are plenty of variations of both trading and investing strategies. But momentum trading and value investing are two examples that make a clear distinction between traders and investors.

Who are the hare traders and tortoise investors competing with?

In the case of the traders, they’re up against the tens of thousands of professional traders at investment banks, hedge funds and other money managers. These guys are paid highly to be on the case, every single moment that the markets are open.

More than that, they’re each specialised in a tiny niche of the markets. If you want to trade against those guys, and come out on top, you’d better be really sure you know what you’re doing.

On top of that are the trading algorithms – computer programmes that can switch positions in milliseconds. They’re programmed by the kind of people that do STEM subject PhDs at MIT. Let’s face it: trading against these, a private individual doesn’t stand a chance.

As for the investor – especially the value investor – they’re competing with market fashions and fads. Things are in or out of favour due to whatever meme is currently circulating. Yesterday’s Campari is today’s gin is tomorrow’s sherry. (Isn’t it about time the last one had a come back?)

So you buy sherry, maybe even some Campari. And you wait for tastes to change.

Next, traders and investors have a different information requirement.

Traders need a lot of information, and they need it instantly. They need real-time news, data and charts. Unfortunately, for the private individual, it’s hard to keep up. Remember: the pros and the algos are already on the case, and are likely to get in first.

Investors also need a lot of information. But they can take their time to digest it. They can study the fundamentals of a company…read up about an industry…analyse a stock’s valuation…weigh the pros and cons of investing, or staying invested (perhaps over a glass of sherry). There’s a lot of up front work, but afterwards the ongoing information requirements are relatively light.

Which brings me on to time intensity. Traders, because of the information and activity loads, have to spend a lot of time on their strategies. This is a constant activity, at least if they’re taking it seriously.

Longer-term investors, meanwhile, shouldn’t have to do anything on a daily basis. If they check they’re portfolio once a quarter, and do a full review once a year, that’s usually enough. In fact, for best results, most of the time they should try to ignore the daily and weekly noise.

Since traders have high time intensity every day, obviously they have high requirements on their time overall. Whereas investors have a low to medium overall time intensity. A lot of work goes into choosing the right moves, but then it’s a light load as they wait for them to work out.

As for the risk level of each approach, this is medium to high for traders and low to medium for investors. A trader is more likely to put money into inherently high risk areas, such as chasing bubbly tech stocks to the moon (and possibly back again). Get distracted, or sick, be offline (e.g travel), or enjoy a relaxing lunch, and you could get burnt. This is like when the hare in the story takes a mid-race nap.

Ah, but what about stop losses? Well, those don’t always work.

When markets break downwards, liquidity often dries up. The market could plunge below the stop price without the order being filled. The trader is left holding the (shrunken) baby.

What about the investor? Well, of course, they’re taking risk too. No one gets their stock picks right 100% of the time, not even an investing great like Warren Buffett.

If your investment horizon is less than a year or two – by which I mean you will need to liquidate into cash within that time – then the risk of stocks is high. But if your horizon is five years or more, then the risks of owning stocks are low.

This is especially true for value investors. Buying a cheap stock already makes it lower risk, for the patient investor. When is the stock of the same, solid company more likely to be a loser over a few years? When it’s trading with a P/E of 30, or when you can pick it up with a P/E of 10? I think it’s obvious, but this point is too often ignored.

All of the above feeds into the relative stress levels of being a trading hare or an investing tortoise.

Personality (impatient versus patient)…time horizon (instant results versus all-in-good-time)…competition (the pros & algos versus shifting fashions)…information requirements and time requirements (everything yesterday versus deep-dive fundamentals)…and risk levels (plenty versus little)…

These compound to make trading a relatively stressful activity, except for a select few. Investing has its challenges too – the hardest being to have the patience and conviction to see things through. But the investor is far more likely to come out, after decades at it, with hair and heart intact.

Last but not least, there are the tolls paid to the finance industry to consider. By these, I mean all the fees, trading commissions, spreads and constant clever ways that the finance industry finds to extract money. Fat bonuses gotta be paid somehow…

Of course, you can’t avoid all of the costs, and it’s reasonable to pay something for a good service. Every broker will charge custody and account fees. Even the lowest cost ETFs have a fee, plus embedded trading costs from portfolio churn.

But traders – due to their high volume activity levels – take the biggest hit. Plus, of course, private traders get doubly whacked. They pay massively high trading commissions and suffer bigger price spreads when compared with the professionals.

This is a crucial point: it’s very hard to make trading strategies that work for the pros also work for private traders. The costs are killers.

It’s like trying to swim against Olympic champion Michael Phelps, but with lead weights attached to your legs. You have to paddle fast and hard just to keep your head above water, let alone make forward progress.

On the other hand, longer-term investors carry less dead weight, because they trade infrequently. Okay, they’re tortoises with heavy shells, and I’m mixing metaphors here. But shells can also be used for buoyancy. The air of lighter commissions already lightens the load.

 

Are you a hare or a tortoise?

Ultimately, whether you choose to be a trading hare or an investing tortoise will come down to personality, personal situation (e.g. working or retired) and your choice.

Shorter-term trading strategies can be profitable for private investors. But going down that route requires a huge amount of expertise and commitment.

Longer-term investing, on the other hand, is a much easier path to profit for almost all private individuals.

If you’re wondering which way to go, just remember Aesop’s fable. Slow and steady wins the race.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.

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