Accounts in which investors trade little do better than accounts that are more active.
I recently read about a study Fidelity conducted several years ago on its client brokerage accounts. The study sought to identify the best performing investors by examining their account returns. They came to a startling discovery: top investors had either died or forgotten to log into their accounts for an extended period of time. Maybe they forgot their passwords and got locked out. In any case they didn’t bother to reactivate their account and password.
It is easy to conclude that accounts in which investors trade little do better than accounts that are more active. Or at least that’s what comes to mind.
There are several reasons why this makes sense:
1) When you often buy and sell stocks, you incur costs
You typically have to pay a commission to buy and sell a stock. If you do it frequently the returns are reduced under the weight of the costs. Even if you lose 1% of the value of your portfolio to fees each year, this could eat away at a significant portion of your returns over time. Also, when you buy and sell stocks, you lose money due to the bid-ask spread. The difference varies from company to company, but this negative factor also adds up and weighs down returns over time. And let’s not talk about taxes. When you sell for profit you have to pay taxes, the capital gain. Therefore, you will have less money to reinvest.
2) When you also buy and sell stocks, you pay an opportunity cost
I’ve read some academic research that showed how the stocks investors sold tended to do much better than the stocks the investor replaced them with. For example, if you sold Johnson & Johnson (JNJ) in 2000, you lost a stock that returned several times its original cost.
If you replaced it with a trending stock like Nokia, for example (very popular stock during the dot com bubble), you would have lost money and losing Johnson & Johnson. If you had just sat back, you would have made a lot of money. That difference between what you could have gotten by patiently holding on to Johnson & Johnson and the actual result of buying Nokia in 2000 is your opportunity cost. Chasing what’s trendy cost investors a lot at the turn of the 2000s.
3) When you switch horses just because you are profitable, you could miss out on great opportunities
Many investors fall into the trap of thinking you won’t go bankrupt by consolidating a profit. The problem is, you won’t even get rich. This is because if you look at the Pareto principle, 80% of the results would be concentrated in the 20 % of the richest companies. In other words, if you exit the top 20% of companies that generate the most capital gains and dividends too early, you’re shooting yourself in the foot. And if you replace these actions with lower quality actions, you are exacerbating your mistakes.
Peter Lynch describes it as "cutting flowers and watering weeds".
Let’s take a striking example: PepsiCo. Whoever bought it in 1983 and kept it until today would have had a performance (excluding dividends) of over 9,000%. If instead you had been satisfied to sell when the price had simply doubled you would have missed an incredible opportunity.
Investors tend to trade a lot, chasing what’s hot and selling what’s not. Eventually they end up consistently buying high and selling low, which turns out to be costly for long-term returns.
We could compare the securities portfolio to a bar of soap: the more you move it, the smaller it becomes.
Original article published on Money.it Italy 2023-07-05 14:01:34. Original title: Trading, perché è meglio non movimentare troppo il portafoglio titoli?
