Trading, Investing, and Costs

How much does excessive trading cost?

Source: Sugarbush.com

At the Sugarbush ski area in Vermont, there’s a quiet, ungroomed, expert-only part of the mountain known as Castle Rock. 20 years ago, owner Les Otten wanted to “upgrade” the section with a high-speed quad. The locals protested, sporting signs and bumper stickers that read: “More Rock. Less Otten.” These days, I feel that I should be carrying a placard around the market that reads, “More Investing. Less Trading.”

Excessive trading increases transaction costs and exposes you to a performance headwind. An annual turnover of 100% costs the typical investor about half a percent per year. This may not seem like much, but it adds up. And turnover can expose portfolios to “tax-drag” that can subtract another 0.25%. Most high-turnover portfolios don’t add enough value to justify that degree of trading. And there are some funds where the turnover can be 200% or more.

Source: Michael Kitces

The other extreme is Warren Buffett, whose preferred holding period is “forever.” If that’s the case, you have to be very careful what kind of stocks and bonds you buy and what price you buy them at. This seems sensible, but I have two observations. First, none of us live forever, so a forever holding period is unrealistic. Second, you can’t hold a bond forever. The money comes back when the bond matures, and has to be reinvested.

To excel in the market, active investment is appropriate. But we should use moderation in all things. The churning, burning, price-chasing, panic-driven buying and selling that’s been common the past couple of decades is anything but focused. More often it seems like many folks are part of a stock-of-the-month club. This seems likely only to benefit those making commissions off of trading.

In the end, Les Otten didn’t expand Castle Rock – he has said he “would have been lynched.” It remains a quiet, challenging set of expert ski runs. Let’s hope quiet, thoughtful investing also wins out.

Douglas R. Tengdin, CFA

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