Ask Colin

There are a lot of overhead costs to trading. Is it worthwhile?

I gave a presentation on this at the ATAA conference in 2000. The feedback indicated that my audience did not want to hear what I was saying.

My presentation was a summary of some of the research done in the US by Terrance Odean. It backs up what I have been saying for years and that Dr Alexander Elder has also been teaching for as many years.

Odean's conclusion from examining the accounts of over 30,000 clients at a discount broking house over a number of years in the 1990s was that the more you trade the less you tend to make. Basically, the transaction costs kill you. That and slippage, which you did not mention, but can be bigger than transaction costs. Then there are all the other overheads. Bear in mind too, that Odean was studying a period which was a strong bull market.

In order for active traders to beat investors, they have to make a higher gross profit in order to get the same net profit. Odean found that both active and relatively passive investors had roughly the same ability, resulting in similar gross profit. So, the more you trade, the greater your transaction costs and the less net profit you make.

You also mentioned taxation and that is another powerful element in the total situation. Traders have to pay higher tax than investors who can avail themselves of the concessional rate on capital gains. Also they can not compound gross returns over any appreciable period like investors can.

I think that the evidence is very strongly that trading is injurious to your financial health. However, I suspect that most people are trading for other reasons than that they think it is the best way to maximise returns. A huge number trade for the excitement, lifestyle, glamour or similar. Another large group trade because they have not saved enough earlier in their life and are trying to do the impossible now.

As I said at the start, quite a few of us try to tell them, but they do not want to hear what we have to say.