As a former day trader, I know the mindset of many first-time day traders. Without proper training and tools, the novice day trader may see investing as a competitive game. Many first-time day traders (and long-term investors as well) may wake up to the fact that investing is a business when they fill out their tax forms. That's when most of these folks finally realize the amount of money they've spent on trading fees, commissions and losses. For myself, the IRS convinced me that day trading is a business, not a game.

Long-term investing also is a business; however, the IRS sees it differently as you'll learn below. Long-term investing may not be a full-time job for you. It is a means to a goal – something like college for the kids or a first or second home or retirement. In that case, investing is not a business as much as it needs to be conducted like a business.

One of my favorite books from the past, Gaskell's Compendium of Forms, written and published in 1882, deals with aspects of business, but it does not deal with investments. Why? Because ordinary individuals did not have the time, money or tools to invest in the stock market in 1882. With that said, Gaskell offers some great “Rules for Conducting Business” that are as pertinent today as they were over a century ago.

Here are a few of those rules and how they apply to long-term investing today:

1. Enter into a business of which you have perfect knowledge: Warren Buffet would approve of this rule. If you plan to invest, then invest in something you know. If you know everything about widgets, then learn more about the company that makes widgets. Learn everything you can about how widgets impact society, what others say about widgets, the past and future projections of widgets and more. No knowledge is “perfect,” but you can come close.
   
   
2. Attend to the daily details of your business: Although long-term investors may eschew daily views of a real-time stock chart, it is your business to check on daily news. As a business owner (or owner of a stock), you need to stay on top of what is happening with those widgets. News, not rumors, can affect how you handle that investment.
   
   
3. Avoid overstocking: Although Gaskell was talking about shelf goods, his advice applies to portfolios as well. Diversity is key, so you need to know a lot about several different stocks in case one stock slips out from under you. While some investors carry more than five stocks in their portfolio, beginners might keep to less than five stocks. You'll learn that keeping up with five stocks almost constitutes a full-time job. Unless you were born rich, then you may already have a day job. Don't lose it over keeping track of your portfolio.
   
   
4. Purchase goods for cash: Gaskell was a hound against credit. He stated, “The credit system has bankrupted more people then perhaps all other causes put together.” And, this was in 1882. Nothing much has changed there, as you can witness by the current economic problems. You may have purchased land or housing with credit – that's just the way these types of investments work unless you had the foresight to save enough for the entire purchase. But, for stocks and other paper investments, it's best to pay cash (if your brokerage allows credit (margin)). There is no sense in adding interest rates on top of brokerage fees and commissions, let alone possible losses.
   
   
5. Curtail every possible expense, hold on to the profits; let them accumulate. Avoid every outside speculation: Gaskell nailed this one, although he wasn't addressing a stock portfolio. The only way to “curtail every possible expense” is to avoid day trading and hold onto your investments when they're heading north. Let them accumulate, don't listen to rumors, trust your intellect and your sense of knowledge and sell only when you feel the time is right. As I told my mother once, “You haven't lost anything on that stock unless you sell it.” Holding sometimes is the best way to overcome possible losses.

Long-term investing could be conducted like a business, and day trading can be conducted as a business – a minor difference, but a huge one when it comes to Uncle Sam. Most day traders hold their positions for a few hours or days, as they seek a quick profit on minor price fluctuations. At the end of the year, they may have hundreds of stock transactions to report on their tax returns (Schedule D).

These day traders may call themselves “traders,” as opposed to “investors.” Traders are taxed differently from investors and dealers, but sometimes that boundary seems slim. The issue centers around whether a person actually is in the business of trading stocks, rather than in the 'business' of investing for the long term. Court cases dealing with this issue mainly were created before Internet trading. But, those court cases help to define the difference between someone who trades for a living and someone who invests for the long term. Basically, the courts have found the following defines a trader:

Courts have required evidence of:

• Frequent, regular, and continuous trading activity
• Substantial time and energy devoted to trading activity
• Goal is to profit from short-term market fluctuations rather than from long-term gains or dividend income

Other considerations include:

• Overall profitability of the activity after expenses
• No other regular full-time job or profession
• Eligible for trader status year after year

Additionally, the IRS will look for:

• Daily record keeping activity
• Independence in decision making and research activity
• Minimal dividend or interest income from trading activity
• High volume of transactions, i.e., number of shares traded, not dollar costs
• Positions held for less than thirty days

Are you willing to do all the above to become a trader? If not, then welcome to the world of long-term investing. Although you might not see some of the tax benefits that traders enjoy, you also won't need to experience a high-stress full-time job that may or may not keep food on the table. Plus, your Schedule D will be a lot less work come April 15th.

Until Later,
Linda Goin