“Most people think buying is investing, but they’re wrong [it] doesn’t make you an investor any more than buying groceries makes you a chef.” – Gary Keller
After contemplating the topic of “Trading vs. Investing,” I found that Investopedia already has an overview of this juxtaposition, so I’m not here to rehash all of that. The article is a reasonable take on the subject, but I think it misses some nuances of how I’d view it from a financial planning/advisory standpoint. Plus (of course), we can consider how this concept applies more specifically to Alts. While this edition is a bit more contemplative than usual, I think we’ll also find some practical applications. Here we go!
Finding your purpose
Perhaps it’s because I’m living inside the world of financial services, but I disagree with the statement (in the above-referenced article) that people use “trading” and “investing” interchangeably – although I do agree with the assertion that there is some confusion surrounding these two terms. It seems pretty straightforward that when a person (or team) is performing the act of buying and selling “stuff” – e.g., stocks, bonds, mutual funds, ETFs, commodities, derivatives, etc. – they are engaged in trading. That’s trading in a very operational sense. It’s simply the execution of an instruction, and I bring it up merely to differentiate from what I intend to discuss today: the “why” behind those trades is what matters. It all comes down to purpose and intent, and the following stock-purchase examples should help to clarify:
- A trade: Buying ABC stock because one thinks the company will announce (unexpectedly) fantastic earnings later today that will push the stock price higher and allow for immediate gains.
- A trade: Buying ABC stock because it’s at a support level (on a chart, aka “technical analysis”) that implies it could move higher, resulting in some short-term gains.
- An investment: Buying ABC stock because one believes in ABC’s management team, business plan, balance-sheet management, and potential to drive earnings growth and the stock price higher over the next several years (and, of course, grow dividends along the way 😊).
On the surface, two examples above are inherently short-term and the other is longer-term, but the timeframe alone doesn’t tell the whole story. For instance, shorting the stock of a regional bank (i.e., betting the stock price will fall in value), based on the belief that the bank will be doomed sometime over the next 3-5 years, is just a trade. On the other hand, a company purchased as an intended “forever” position can quickly be sold if the original thesis is unexpectedly undermined; that’s still part of investing.
It depends on what your definition of “Alternative Investments” is
Going back to the first edition of Alt Blend, in October of 2020, we very broadly defined an Alternative Investment as “anything that doesn’t fall into the conventional categories of stocks, bonds, and cash.” But that definition ignores why we use Alts, which is to introduce different risk, reward, and/or return possibilities into portfolios. That’s also why I like to focus on private investments, which are (again, verbatim from Alt Blend #1) “a subset of alternative investments where the underlying holdings or transactions cannot be accessed via publicly traded markets; therefore, they inherently involve a greater degree of illiquidity.”
Thus, the broad spectrum of Alts includes highly liquid assets like cryptocurrencies, and a lot of trading is surely taking place in the crypto space. But, as we traverse the liquidity spectrum toward less-liquid holdings, particularly within private markets, an “investment” mentality becomes more of a requirement. At the extreme, a given Alt strategy may require the mindset that it will literally be owned forever.
Perhaps adding to the confusion of this topic, there exist alternative investment strategies that are built on a significant amount of trading. For example, merger arbitrage – where trades are designed to profit from the notion that one company is acquiring another – naturally involves many underlying trades using various securities of both the acquirer and acquiree. If done correctly, those trades are implemented with thoughtful risk/reward parameters and diversified across many merger events to roll up to an overall fund. Because the trades are typically structured using very liquid holdings, “merger arb” funds are among select strategies that can be true alternatives (i.e., offer low correlation to stocks and bonds to help provide diversification) while offering daily liquidity to investors. However, the point for today’s conversation is that – even though merger arb involves a lot of shorter-term trading – the end product is a strategy appropriate for long-term investment. And, in case you missed it, we did an audio-only edition of Alt Blend with a credit arbitrage manager in June of 2021 (credit arb is a subset of merger arb that only uses fixed-income securities for expressing the merger trades).
Conversely, could a long-term, illiquid investment be approached as a trade? I suppose that argument could be made, but I don’t think it would be easy. If anything, it would ultimately be decided by the purchaser’s mindset and the role that holding is intended to play within their financial situation. Let’s see if we can get more clarity on that front.
Roleplay
What we advocate in our role as advisors is to a) develop a long-term financial plan to view all elements of one’s financial situation comprehensively, b) allow that perspective to drive a needs-based framework for risk management, tax/estate planning, and investing, and c) find the appropriate investment solutions to fill the various roles required within that overall framework. The investment solutions we utilize within this planning approach will be just that: investments. They are a means to an end within a robust process created to help clients reach their goals.
When implementing a financial plan, “investing” is the only tool for the job, regardless of the instrument used (e.g., stocks, bonds, alts, etc.). If a given client wants to dabble in trading, it’s typically because they enjoy the trading process or found a one-off company they genuinely believe is a good idea to purchase. If they must do this, it occurs outside of our mandate, and the positions are sized so as not to disrupt the investment plan we have implemented. Whether their trading works well or not, it will have a limited impact on their financial well-being. We are focused only on investing with a purpose on behalf of our clients, and Alts play a vital role in that approach.
Investing is part of the plan. Trading is not.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
