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TMFBro (< 20)

Trade more, earn less



February 16, 2010 – Comments (0)

So says Jason Zweig in a recent WSJ article:

"An analysis of nearly 2 million trades by discount-brokerage customers found that those who traded the most earned returns no higher than those who traded the least. After deducting brokerage costs, the fastest traders fell far behind the slowest. According to Morningstar, mutual funds with the highest portfolio turnover rates have underperformed the slowest-trading funds by an annual average of 1.8 percentage points over the past decade. A study of pension-fund stock portfolios found that, on average, the funds would have raised their annual returns by nearly a full percentage point if the managers had gone on a 12-month vacation and never made a single trade."

OK, I buy that. 

Then there's this:

"[The underperformance] is probably because so many investors tend to sell winners too soon. Only later—if ever—might you notice that you replaced a winner with a stock that isn't as good. Meantime, locking in a gain makes you feel that have accomplished something."

This seems to say that investors sell high but could have sold higher, which contradicts other studies (of such things as the flow of money into and out of mutual funds) that show investors jump into hot investments too late and sell once they've cooled off -- in other words, they buy high and sell low. I suppose it's likely that -- given the millions of investors out there -- there's more than one way for us to screw up.

Either way, I agree with the general advice: Most people would be better off  not trading so much. Yes, there are traders and high-turnover funds that do well, but that's not the norm. If you're doing more than rebalancing your portfolio once a year, then track your after-cost and after-tax returns. You may be earning less by doing more. 

Robert Brokamp is the senior advisor for The Motley Fool’s Rule Your Retirement service.



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