Abandon “Buy and Hold” at Your Peril

Focus: MARKETS

Howard Gold Image Howard Gold Founder & President, GoldenEgg Investing

Like their counterparts of today, promoters…pushed ‘opportunistic’ trading strategies, usually involving options and futures contracts. But the pervasive pessimism of 1982 preceded one of the greatest equity bull markets in history.”

And by abandoning “buy and hold” right now, investors not only might be jumping ship at precisely the wrong time; there’s no evidence that trading more aggressively will work, anyway.

Two academics, Brad M. Barber of UC Davis and Terrance Odean of UC Berkeley, have done extensive research on individual investors and traders, and their findings should deter even the hardiest souls from going that route.

You might recall their 1999 paper in which they studied the trades of 66,465 US households with accounts at a large discount broker. From 1991 to 1996, some of the best years of the 1990s bull market, “those that traded most earned an annual return of 11.4%, while the market returned 17.9%.”

Investors, they say, are overconfident in their own abilities to make winning trades. “Those who trade the most are hurt the most,” they wrote. “Our central message is that trading is hazardous to your wealth.”

Barber and Odean then joined with two Taiwanese scholars to do an even more comprehensive 2006 study.

They got records of every trade made in Taiwan from 1995 to 1999 and found that “the aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points” and that “virtually all of individual trading losses can be traced to their aggressive orders.”

“Trading in financial markets leads to economically large losses for individual investors,” they said, pegging those losses at $US 32 billion during the period studied, or $US 6.4 billion annually. “This is equivalent to a staggering 2.2% of Taiwan’s gross domestic product,” they wrote.

Meanwhile, they found, institutional investors racked up “abnormal returns of 1.5 percentage points after commissions and transaction taxes.” Their conclusion: “Individuals lose, institutions win.”

When I caught up with Professor Barber this week, he acknowledged that cultural factors—including a propensity among Chinese investors to view stock trading as a form of gambling—may have played a role in the results, but don’t account for most of individuals’ underperformance.

 
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