The following article appeared in the Australian Financial Review on March 26, 2018.
Successful investing is hard. It gets a lot harder, though, when you try to rush your way to riches.
It’s become fashionable for market commentators to argue that buy-and-hold investing is dying. The argument goes that, as the pace of disruption and change accelerates, investors should become more active.
I’m more of a buy-to-hold investor myself, although I acknowledge that sometimes facts change and that my view should change too. I also agree that the pace of change has accelerated.
My bias is towards patience, though, because the reality is that empirical research confirms that how often one trades is inversely correlated to returns.
Good luck, traders. You’ll need it.
The body of work here is deep. A prime example is a fantastically named paper, Trading is Hazardous to your Wealth, published by Brad M. Barber and Terrance Odean back in April 2000. Barber and Odean found that, of 66,465 households with discount brokerage accounts tracked between 1991 and 1996, the most active cohort of traders earned only an 11.4 per cent annual return compared with a market return of 17.9 per cent.
Compounded over five years, the cumulative return of the high-turnover active investor would have been 71 per cent compared with 127 per cent for the market: A brutal degree of underperformance, and one with higher costs to boot. Oh, and by the way, Barber and Odean found that the cohort of infrequent traders outperformed the market with an annualised return of 18.5 per cent.
Maybe you’re thinking that data set is too old school and not reflective of the current disruptive era, or maybe that Americans are just bad investors. Consider instead a piece of research done in 2016 by the blog CuriousGnu about the returns of 83,300 private day traders who deal through a London-based brokerage, eToro.
The writer found that a staggering 79.5 per cent of the day traders had lost money in the 12 months to July 31, 2016. Not only did they lose, but they lost big. The median 12-month loss was 36.3 per cent!
Barber and Odean also found ugly results when they zoomed in with a study of Taiwanese day traders. The duo found that, over a period stretching from 1995 to 2006, profitable day traders consistently made up only about 5 per cent of the sample.
It shouldn’t surprise anyone that studies of different periods and markets point towards high-turnover investors receiving poor average returns. After all, not only are day traders paying heaps of commissions to brokers, they’re typically making decisions to buy or sell based on data that is disconnected from long-term fundamentals.
All that is bad enough, but worse is that such a mindset is not limited to novices. I once encountered another pro in Sydney who said he wouldn’t be a buyer of a stock at $18 but, if momentum picked up and the price rose to $21, he’d start buying.
I thought I must have misunderstood – after all, I wouldn’t tell a car dealer that I wouldn’t buy a car at $18,000 but would turn into a buyer if the price increased to $21,000 – but he was serious. I imagine this would be a conversation that, had an advanced alien race scouting our planet overheard, would have motivated them to move on to Venus.
Here’s hoping more investors join the long-term crowd, though, because it could prove a win for individuals, companies, and capital markets at large.
Joe Magyer is the chief investment officer of Lakehouse Capital. This article contains general investment advice only (under AFSL 40069)
All of the commentary, statements of opinion and recommendations contain only general advice and have not taken into account your personal circumstances.