Overtrading

September 1, 2015

Investing does not need to be difficult. While there are an incredible amount of variables out there, adherence to a well thought out asset allocation and financial plan can help anyone weather through even some of the most trying markets. However, there are several mistakes that an investor can make that can cause them to lose track of their goal. One of the more common investing mistakes out there is what we refer to as “overtrading.”

 

The name itself is fairly self-explanatory. This is when an investor tries to rapidly trade in order to keep up with the current news cycle. While I am no psychologist, I believe the behavior is fairly rationale but ultimately damaging when it comes to managing money. In life, we have learned to avoid pain and danger as a self-sustaining necessity.  For most, it only takes touching a hot pan once to learn that it is something they should avoid going forward.

 

When that same logic is applied to investing, it can be easy to see how investors get themselves in trouble. As stocks fall, investors experience emotional discomfort and it is very reasonable to want to avoid the pain by selling out, much like staying away from a hot pan. Unfortunately, in investing this has proven to be a losing strategy. As bad as the Great Recession was, what has followed has been one of the strongest bull markets of all time.

 

Beyond potentially missing returns, there are several other disadvantages to overtrading:

* Transaction Fees: It would only take 4 trades of a $10,000 mutual fund position to reduce returns by 1% ($25 transaction fee).

 

* Poor Information: The news is a terrible source of investment information. Remember that the media's revenue comes from advertisements and the best way to get attention is to exaggerate.

 

* Trader Fatigue: There is an emotional burden of trying to trade through volatility which can result in poor decision making and distracted behavior.

 

* Unintended Risk: It is easy to lose track of your overall portfolio construction and end up in with an unbalanced and ultimately risky portfolio.

 

I have seen overtrading ruin many individuals' retirements and it always sticks out to me as one of the more dangerous mistakes an investor can make. Often we will hear stories of how a friend/family/advisor has doubled their investment since the end of 2008 by trading in and out of stocks and cash and wish that could be us. Understand that the S&P 500 has returned over 150% since the end of 2008 and if they have only doubled, they have underperformed by over 6% annualized since then. One of the easiest ways to outperform your peers is to pick the appropriate balance of investments and stick with it over the long haul.

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