Investing vs. trading: Understanding the differences

Investing and trading offer ways to potentially earn money from the stock market. While both involve putting money into various assets, such as stocks, bonds or commodities, their strategies and time horizons are different.

Anyone can pursue either option or both, but your path likely comes down to your savings goals, risk tolerance and larger financial plan. Let's explore the traits of investing vs. trading to see how these methods could fit your needs.

Investing involves buying and holding assets, such as stocks, bonds, mutual funds or exchange-traded funds (ETFs), over an extended period of time. The primary goal is to earn money through capital appreciation, dividends and interest payments.

This wealth-building approach can suit beginner to advanced investors, typically with a major long-term goal, such as funding their children's education or their own retirement. Investors often take a passive stance, relying on overall growth of the market and their chosen assets' performance.

Some investors take a do-it-yourself approach, working on their own to analyze financial statements, industry trends and macroeconomic factors to find companies or assets with strong growth potential. Many investors consult with a financial advisor and/or invest through accounts managed by investment professionals.

Trading focuses on short-term market movements. Traders aim to profit from the market's ups and downs, buying assets at a low price and selling them when they believe the price has risen sufficiently.

Traders also invest in stocks, bonds, mutual funds and ETFs. Some advanced traders may use more complex securities, like gold or crude oil commodities, or futures and options, which are financial derivatives used to speculate on market price changes or to hedge risk.

Trading may appeal more to people who enjoy actively participating in the markets. Traders need to constantly monitor market conditions, analyze charts and indicators and then make informed decisions on when to buy and sell. They focus on historical price data and market trends rather than the underlying fundamentals of the assets.

People can be both investors and traders, but sometimes they choose to stick to one lane based on how each path matches their own financial strategy. Consider these factors as you think about the best way to build up your nest egg.

The long-term time horizon for investing often spans several years or even decades. Investors are focused on their investments' potential to grow steadily over time, riding out short-term fluctuations and market cycles.

Trading is typically associated with a shorter time horizon, ranging from minutes to days, weeks or months. Traders are focused on capturing short-term price movements and may have multiple trades within a single day. Day trading has often gained in popularity during longer-term bull markets when trends are easier to identify, but many day traders drop out during bear markets or markets exhibiting high volatility.

Investing lets you participate in the overall growth of the economy and take advantage of compounding returns over time.

Trading lets you take advantage of short-term market fluctuations and potentially generate quick profits.

Investors usually take a more hands-off approach, with fewer transactions and lower trading frequency. Because investors often use professionally managed funds, such as mutual funds or ETFs, they also don't have to pick their own investment securities.

Traders take a more active approach, constantly watching the markets to make the best moves. With that active approach also comes more flexibility, as traders have the freedom to choose a variety of investment types and strategies.

• Read more: "Active investing, passive investing, or both?"

Investors may be considered more risk-averse. They diversify their portfolios to reduce market risk, spreading their investments across different asset classes, sectors and geographic regions.

Traders are generally more open to risk due to the short-term nature of trading. To curb that, they may use risk management strategies like setting a stop-loss order, which limits potential losses by automatically selling a security if its price declines to a certain level (the stop price).

With fewer trades and a long-term perspective, investors generally incur lower transaction costs compared with active traders. Many investors seek low-cost mutual funds and ETFs for investment vehicles.

Traders may incur more costs through frequent trading and capital gains taxes, though traditional investors are subject to these taxes as well.

Selling an investment at a profit may trigger a capital gains tax, which can vary depending on how long you've held the asset. Because investing is often associated with longer holding periods, you'll usually face long-term capital gains (assets held more than one year).

Trading is more often associated with shorter holding periods and short-term capital gains or losses (assets held less than one year). Long-term capital gains are taxed at lower rates than short-term capital gains.

With investing, you often gain profits through dividend-paying stocks or dividend funds, and those dividends may be taxed as ordinary income to the investor. However, dividends paid by many US exchange-traded companies may be taxed at lower "qualified" dividend tax rates if the investor owned the stock for the required longer holding periods.

Since trading is more focused on shorter-term holding periods, traders typically don't benefit from lower "qualified" dividend tax rates.

Investing often uses tax-advantaged accounts, such as IRAs or 401(k) plans. These accounts can come with tax-deferred growth or tax-free withdrawals in retirement, given certain conditions are met.

Trading can be done through tax-advantaged accounts, but more frequently it's done through taxable brokerage accounts where capital gains tax may apply.

Trading and investing are two popular ways to access the financial markets, each with unique risks, characteristics and objectives. To start investing or trading, you'll need a brokerage account or retirement account, such as an IRA.

Investors and traders can get started on their own, but given all the approaches and strategies for each, you may want to seek the help of a financial advisor who can take out the guesswork. They can direct you down a wealth-building path that fits your personal timeline and financial goals.