Why most people should invest, not trade
Studies spanning decades show the same picture: the more retail investors trade, the worse their results. Doing nothing is the most underrated strategy there is.
There's hardly a field where more effort so reliably produces worse results. Trade a lot, and you pay a lot in fees, make more decisions, and get more chances to be wrong.
Then there's timing. The strongest price surges often sit right behind the worst days. Anyone who exits out of fear misses exactly that recovery and gets back in later, at a higher price.
A savings plan solves this by removing the decision entirely. You buy when the date arrives, not when it feels right. That sounds boring, and that's exactly why it works.
If the subject still appeals to you anyway, there's a sensible way to do it: the large majority of your money in the boring savings plan, a small slice as play money whose total loss wouldn't hurt you. That way you learn without ruining yourself.
The best-known study, by Barber and Odean, analyzed accounts at a large discount broker and found that investors with the highest turnover trailed the market average considerably, while the most passive accounts performed best. The return gap was explained largely by trading costs and poor timing, not by poor stock selection alone.
A second effect is the return gap between funds and fund investors. Time-weighted fund returns regularly exceed the money-weighted returns of the investors in that same fund, because money flows in after strong gains and flows out after declines. That behavior costs money regardless of which product you chose.
On the timing argument, studies show how much the final outcome suffers when the best trading days of a period are missing. The effect is so large because returns aren't evenly distributed, they're concentrated in a handful of days, and those days fall disproportionately during periods of high uncertainty, exactly when investors are typically not invested.
Summary
- More trading tends to produce worse results for retail investors on average.
- The strongest days often sit right after the worst ones.
- A savings plan works because it removes the decision.
Did you get it?
What did Barber and Odean find in their analysis?
Investors with the highest trading turnover performed worst, and the most passive ones performed best.
What's the return gap between funds and fund investors?
Investors earn less than their own fund does, because they buy after gains and sell after declines.
Why is exiting during a decline so costly?
Because the strongest recovery days fall disproportionately during periods of high uncertainty, when you're then not invested.
Sources and further reading
- Barber, B. M. and Odean, T. (2000), Trading Is Hazardous to Your Wealth, Journal of Finance View source ↗
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