Is Day Trading Better Than Buy and Hold?

Is Day Trading Better Than Buy and Hold?

A recent article in the Los Angeles Times suggests that there’s a growing inclination among baby boomers to shift to day trading as a strategy to make up for all the losses they incurred since 2008.  The average 60-year-old currently has only $114,500 in his or her 401(k), according to benefits firm Aon Hewitt, and half have less than $37,300.  At the same time, the increasing availability of brokerage windows – accounts within 401(k) plans that allow daily trading in most any publicly-traded funds and stocks – is making day trading easier.   Aon Hewitt reports that about 29% of companies offer them, up from 12% a decade ago.

Strategies abound.  There’s 49-year-old Vlad Tokarev, for example, who buys or sells a mutual fund linked to the Standard & Poor’s 500 stock index at the end of every day. His goal is to profit from temporary fluctuations in stock prices, so he buys when stocks are falling and sells when they’re rising.

Joe Hansman, a 29 year-old, shifts money among two conservative mutual funds in his 401(k) and his employer’s own stock.  He trades 10 to 15 times a month, steering money into the company stock when he expects it to rally for a few days.  While the results of this strategy are yet to be determined, the risk is summed up by his wife: “Just don’t lose everything. If you do I’ll divorce you.”

Is day trading a good way to help a depleted retirement portfolio catch up to where it needs to be?  From the data I’ve seen, the answer is no.

Dalbar, Inc., a large financial services market research firm, has been performing an annual Quantitative Analysis of Investor Behavior study since 1994 that measures the effects of investor decisions to buy, sell, and switch into and out of mutual funds over both short and long term time frames. Their analyses have consistently shown that investment results are more dependent on the behavior of investors than on the performance of their investments. Their 2010 study found that over the 20-year period from 1991 through 2010, the average annual return of the S&P 500 was 9.1%, while the average annual return of the average equity mutual fund investor was only 3.8%. That’s because investors change their behavior from aggressive to conservative after markets have fallen, and vice-versa. This causes them to sell assets when prices are low and buy them when prices are high.  The more frequently they trade, the worse their returns are.

This doesn’t mean that buy & hold is necessarily the right approach either.  Sitting through a 20% market drop can be a gut-wrenching experience.  An active management strategy designed to reduce portfolio volatility may be just what some people need to avoid the “buy high” and “sell low” behavior so common during periods of market stress.

As I have written before, there is no reason to aim for a higher return than needed, nor to believe that the more trading you do, the better off you’ll be.  Both simply increase risk and volatility.  Focusing instead on managing the risk of the returns needed to support your goals will lead to greater financial peace of mind.

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