The Perils of Frequent Trading

In a recent column discussing a proposal to reward shareholders who invest in stocks for longer periods of time, The Wall Street Journal’s Jason Zweig highlights some interesting data on how trading frequency can impact returns of both businesses and investors.

“Patience is a rare virtue in today’s high-speed markets. The average diversified U.S. stock mutual fund holds its typical position for just 15 months, according to investment researcher Morningstar,” Zweig writes. “This past week, Oracle’s stock lost 10% in a day after the company fell short of quarterly earnings expectations by one penny per share, and shares in FedEx dropped by 9% in two days after a sharp decline in quarterly profits.” He says that makes corporate managers “gun-shy”, which may be impacting long-term profits. “A survey of more than 400 senior corporate executives in 2003 found that 59% wouldn’t invest in a project that would generate significantly higher long-term profits if it reduced earnings in the short run,” Zweig notes.

He also points to another study, performed by University of California economists Terrance Odean and Brad Barber, which found that investors who traded the least frequently outperformed those who traded the most by 6.8 percentage points per year.

Zweig’s advice: “Buy an index fund and hold it forever. Or find a mutual fund with expenses under 1% and a turnover rate of 33% or less, meaning it holds its typical stock for at least three years. Or pick a few stocks yourself, buying on bad news and then holding stubbornly through all the short-term noise. Before you buy, write down at least three reasons why you believe the company is a good investment; sell only if those reasons have become invalid.”





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