I grew up in rural Oregon. And, like most kids growing up in rural anywhere, I spent a fair amount of time learning how to fish.
One of the great things about fishing as a kid is it’s a great way to learn patience. Imagine casting your line and immediately reeling it back in the moment it hits the water. Every time it hits the water, you instantly conclude there are no fish there. You reel back in and try somewhere else.
It’s pretty obvious this is not a great way to catch fish. It’s not a great tactic with investing either.
Patience is pretty important when it comes to investing. Warren Buffet, when asked how long to hold an investment, is quoted as saying, “Our favorite holding period is forever.”
The Problem with Patience
The problem is a holding period of forever isn’t very exciting. With a 24/7, rating-obsessed news cycle and financial media in need of constantly filling airtime, it’s more popular to talk about what stocks to buy (or sell) today, tomorrow or this week.
High frequency trading (HFT) is the latest iteration of “exciting.” It generates angst among investors and it gets a lot of attention. And I almost get it. It’s a captivating story; people can trot out the “market is rigged” storyline that’s such a compelling part of the HFT debate.
So as an investor, you are bombarded with and force-fed these “exciting” stories. But as captivating as they may be, it doesn’t mean you are better off paying them any attention and certainly not by taking action. As an individual investor, being a “low-frequency” trader is going to make you more money.
The Advantages of Patience
How so? Let’s look at three advantages of low-frequency trading:
1. Minimize Mistakes: One easy but under-appreciated way to be a better investor is to minimize mistakes. A 2011 study found individual investors systematically earn subpar returns even before their costs. Stocks bought by individuals underperform the stocks sold by 2.76% annually in the 12 months after the trade.
The less trading, the lower focus on stock-picking, the lower the chances for mistakes and the massive performance drag it causes. That’s one point for patience.
2. Lower Transactions Costs: Things look even worse after transactions costs. In a 2014 article titled “The Arithmetic of ‘All-In’ Investment Expenses,” John Bogle, the founder and former CEO of Vanguard, estimated the average actively managed fund (a professionally managed fund that typically employs a vast and sophisticated trading team) incurs transaction costs of 0.50% annually.
With an indexing approach, or low-frequency trading, you can reduce this expense to almost zero, saving a full half a percent a year in returns, or $5,000 annually on a million-dollar portfolio.
And transactions costs are even worse when looking at individual investors. One study of 65,000 investors from 1991-1996 showed that net of all costs, the 20% of investors with the highest trading frequency earn 7% less(!) than those trading the least. That’s another big benefit of having some patience.
Source: “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” by Brad Barber and Terrance Odean
3. Taxes: Every trade you make generates a taxable event. So by trading more frequently, you are increasing the frequency of taxable events.
What’s more, since short-term gains are taxed at a higher rate than long-term gains, not only are you generating more taxable events with higher trading frequency, but you are also creating taxable events that are taxed at a higher rate. John Bogle estimates this tax difference can add up to 0.45% annually.
So, while high-frequency trading may get more articles written and media airtime, we suggest you are better off focusing on low-frequency trading. Focus on the things you can control, like minimizing your mistakes, and lower taxes and transaction costs.
A little patience goes a long ways when it comes to being a successful investor.
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