There’s a view of the stock market that the road to success lies in frequent activity. You need to be a market savant, being able to spot trends among the mass of squiggly lines moving up and down the computer screen with each passing second. The problem is, more often than not, the faster you act, the quicker you lose your wallet.
University of California professors, Brad Barber and Terry Odean did a study titled Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors that was published on April 2000 (no prizes for guessing the conclusions of the study!). It found that between 1991 and 1996, individual investors who traded the most underperformed the market by 6.5% annually!
The frequent traders had turned over their portfolios by 250% per year (that’s saying they held a stock on average for 5 months), compared to the average of 75%. Professional fund managers’ results suffer when they turnover their portfolios too regularly and it seems regular folks can’t crack the puzzle too.
The evidence is not just limited to the West. Closer to home in Asia, Barber and Odean collaborated with professors Lee Yi-Tsung and Liu Yu-Jane from the National Chengchi University to study the results of day-traders in Taiwan. Day-traders are stock market participants who buy and hold shares in companies for less than a day – needless to say, they are frequent traders.
The study found that from 1995 to 1999, the day traders are unable to make money as a group after factoring in transaction costs associated with trading. What’s more, 80% of the group lose money with only a minority being able to make money on a sustained basis by frequent trading.
The odds of making money in the stock market are just stacked against those who engage in frequent trading.
What’s a good alternative then? At the Motley Fool, we believe in buying and holding shares in individual companies for the long-term.
Shares of companies like instant beverage manufacturer Supergroup (SGX: S10), multinational conglomerate Jardine Strategic Holdings (SGX: J37) and international retailer Dairy Farm International (SGX: D01) have all seen their share price appreciate more than 10-times from its initial value over the past 10-plus years starting from Jan 2003.
Even a plain vanilla index tracker like the SPDR Straits Times Index ETF (SGX: ES3), which aims to capture the returns of Singapore’s overall stock market by mimicking the movement of the Straits Times Index (SGX: ^STI), can deliver annualised returns of 10.1% for a decade ending 31 March 2013.
That’s not going to make anyone a millionaire overnight, but that’s not what the stock market has been about.
Charlie Munger, vice-chairman of Berkshire Hathaway, once said “Investing is where you find a few great companies and then sit on your ass“ The first step is important, but an investor will never get anywhere without the second step. It’s not activity that matters in the stock market – it’s inactivity.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.