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Buy low, sell high?
Sounds sensible enough. But as was underscored by the stock market frenzy of recent weeks—in which newbie investors piled into stocks like GameStop, driving shares to unthinkable peaks which then crashed back down to earth just as quickly—knowing when to sell can be a challenge.
As the House Committee on Financial Services convenes hearings this week to try and determine what exactly happened during the GameStop mania, a new study titled “The Volatility of Stock Investor Returns,” from researchers at the University of British Columbia’s Sauder School of Business, lays out just how costly actively trading in your portfolio can be.
Caught in the tumult
The researchers pored over nearly 100 years of data from from the New York Stock Exchange, AMEX, and Nasdaq, spanning from 1925 to 2018. They found that while investors were trying to lock in returns by trading frequently, instead they often got caught—typically to their detriment—in the market tumult.
Over 20 year periods, active investors experienced 50% higher volatility than more passive, buy-and-hold investors, the researchers found. Over 30 year periods, the itchier trigger finger set notched 71% higher volatility. Unfortunately for frequent traders, the greater volatility tended to get the better of them; generally, they have terrible timing.
“When the market has been calm and they feel comfortable, they inject money, but then the market becomes volatile and they start to lose money,” explained UBC Sauder assistant professor Dr. Xin Zheng, who co-authored the study with Emory University professor Dr. Ilia Dichev. “The reverse holds true when they withdraw money from the market: they do it after a period of volatility.”
Bad timing
Just how much better off are passive players? In a note to Coins2Day, Dr. Zheng summarized that in a simulation of 30-stock portfolios over a 30-year horizon, buy-and-hold investors outperformed frequent traders by about 2.5% per year.
The buy-and-hold message strikes a particularly relevant note today given that the major indices are hovering near all-time highs. As my colleague Shawn Tully has warned, there is very likely more volatility around the corner.
“The optimists’ manifesto contains a faulty assumption: That by far the lowest rates in at least 60 years are here to stay,” Tully wrote earlier this week. “The idea is that stocks can stay this expensive because they’ll remain so much better than bonds. But that’s only true if you posit that ‘real’ yields, adjusted for inflation, remain in today’s negative territory pretty much forever. It’s never happened before and won’t happen going forward.”
Overall, the performance gap between buy-and-hold investors and frequent traders can be best summed up as: bad timing. “In a nutshell, the findings of this paper imply that investors tend to ‘chase stability’ but in the wrong way, ending up worse off as compared to a passive investor.”
Dr. Zheng’s advice?
“Trade as little as possible.”
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