The fundamental problem with frequent trading is that very few people can consistently outsmart the market — at least not while playing by the rules. Behavioral biases lead many of us to trade at the wrong times. It can be comforting, for example, to buy when stocks are rising and nearly irresistible to sell when they are plummeting, as they did last week. This means buying high and selling low, a fine recipe for financial misery. Furthermore, when costs mount, as they will when you trade frequently, the odds of beating the market are slim indeed.
It’s been long known that these kinds of mistakes have serious consequences. A study by Dalbar, a mutual fund research firm in Boston, found that in the 20 years through December, the average stock fund investor had annualized returns of 3.8 percent, compared with 9.1 percent for the Standard & Poor’s 500-stock index. The average person, in short, would have been much better off buying an index fund and holding it for 20 years.
Now, a new study of affluent investors shows that many well-heeled and apparently well-informed people feel compelled to trade frequently — believing all the while that their trading is excessive. The existence of this “trading paradox” is a central finding of the study, which was conducted by Barclays Wealth, a division of Barclays, the global bank based in London. The study, “Risk and Rules: The Role of Control in Financial Decision Making,” is to be published on Monday. The company provided a copy to The New York Times.
“This trading paradox exists, to one degree or another, everywhere in the world,” Greg B. Davies, the head of behavioral and quantitative finance at Barclays Wealth, said in a telephone interview. “Not everyone is prone to frequent trading, but among those who feel that they must trade frequently to do well, there is a substantial proportion who are troubled by their behavior. This is a novel finding for me.” ...