The Average “Investor” is Truly Awful. Sorry.
Most “investors” react to daily market movements and overtrade to their own detriment
It’s quite common to see people on FinTwit talking about their latest ideas, or announcing the details of their recent “win”.
Personally, I quite like seeing all the vague tweets that proclaim something along the lines of “The Nasdaq is down now, but in the future, it’s probably going to go up. If not, it’s going to go down!” …only to see it quote-tweeted a few months later for a big “I TOLD YA SO!” moment.
I’m here to tell you that it’s best to buy-and-hold; to just keep buying, especially when things are bad. You can sell when things are expensive and you need the money, hopefully not for another 20+ years.
Investing is a long-term undertaking. It can be tempting to trade more as uncertainty rises. It’s usually best to stick to buying, though. Were you buying when things got bad?
I certainly was. Lots of SPY 0.00%↑ and VTI 0.00%↑ with money going into $VFIAX (aka VOO 0.00%↑) 3 days a week. I’m still paying back the last of my loans I took out, just to invest in the market. I’ll pay back my margin loans next.
Alas… Let’s continue…
Addressing Behavior
Frequent trading is the most common culprit for eating away at investors’ returns. As someone who manages money for a living, I can tell you that we spend millions of dollars each year. We invest in research and professional analysts. We pay for alternative data in addition to market data. We conduct surveys of customers and employees. We routinely bounce ideas off one another. Due diligence is a minimum; without that, we can’t invest.
Unfortunately, since trading became free, the average retail trader has begun to fancy themselves a market “expert” of some kind. They aren’t. If you’re using retail tools to trade stocks, then there’s an incredibly high chance that you’re spending a lot of time to lose money vs. holding a diversified fund. I prefer index funds, but honestly, it doesn’t matter. You’ll need to stop over-trading and performance-chasing. You’ll need a long-term plan, and a way to automate your investments. Human behavior needs to be forcibly separated from your money, and automation does this.
Until you’re able to address the behavior patterns and emotions that lead to poor decisions, please understand that you’re simply going to end up with less money in the future. Even for those who feel like they’re winning, they’re typically either losing or have a near-100% chance of losing soon. Trying to beat the #SPX for 20+ years isn’t just a full time job, it’s a full time job for tens of thousands of finance professionals around the world. At least they’re getting paid, because the majority of them won’t beat the #SPX. As a whole, active management has always lost out to the #SPX, just like active traders, despite all of the advantages they are afforded.
Unless you’re getting paid a solid income to beat the #SPX, you should really consider investing in it (or investing in a fund that attempts to beat it, like a large-cap value fund, global equities, whatever). The first thing you need to do is to consolidate your investments in tax-advantaged accounts where possible, and then you need to stop trading. (If you are being paid to beat the #SPX, you should STILL probably invest in index funds to avoid career correlation risk. Imagine losing job BECAUSE you blew up your retirement portfolio!)
If you can’t stop trading then you’re addicted to trading.
Is Trading an Addiction?
Most active traders are addicted to trading. Most are unwilling to review the data necessary to prove this to themselves. Active traders routinely ignore the cost of taxes, trading costs, time and effort, when comparing their performance to that of a DCA-ing mutual fund investor. They will even ignore major losses, or large deposits, padding their imagined “performance”. This comes up frequently in discussions with clients dealing with overtrading. While it’s not a lethal addiction, it’s “dangerous to your wealth.”
Data: Studies on ‘Trading Addiction’
You’re almost done. The article continues after the LoTR meme…. -Avery
Guglielmo R, Ioime L, Janiri L. Is Pathological Trading an Overlooked Form of Addiction? Addict Health. 2016 Jul;8(3):207-209. PMID: 28496959; PMCID: PMC5422017.
Trading Addiction
Hey, you’re still reading! Glad you made it past that PDF link.
Active traders have been studied ad nauseum. There’s many good reasons why your broker lets you trade for free. I want you to think about that one for a moment. They want you to trade as much as possible. Back in the 80’s, they’d have to pick up the phone and call you with their “latest idea”. Now, they update their price target, or ask Zoltan Pozsar to convince Schwab clients that the entire world’s going to explode “Any Day Now⟨™⟩”.
Why, exactly, would brokers lets their clients trade for free? Why would large institutions pay clearing firms so much, simply for the right to take the other side of retail trades? I can give you our reason. Because we have near-unlimited capital, teams of professionals working for us, and we’re willing to put our hard-earned (or borrowed) capital on the line. We’re confident that the bulk of retail traders are wrong. The data proves this. We want as many trades as possible, and brokers are more than happy to oblige with bulletins, data feeds, alerts, options strategies, and market updates that encourage more and more trades.
Take options traders, for example. The majority of retail options orders aren’t for insurance, they’re speculative bets. Retail traders aren’t familiar with Black-Scholes and vol surfaces, and even if they are, it just tricks them into thinking they have more control than they do. They’re unable to select the right strike and expiry. They’re optimistic and sure of themselves when they should be pessimistic and doubting their actions.
Your broker wants as many of those trades as possible. Why? Because they’re selling those trades and profiting off of the spread. Options are only intended to provide insurance and peace of mind, at a cost. As a whole, they’re a losing proposition. This distinguishes options traders from equity-holders. They have no right the profits of any firm, but merely posess a contract allowing them to wager on short-term price movements in the underlying security. As a general rule, retail traders should never have a need to employ options, as doing so will reduce lifetime returns in exchange for some peace of mind.
Edit: Just published by MIT:
Link: Retail investors lose big in options markets, research shows
Using options (for non-insurance purposes) is considered gambling, at least by institutions who aim to profit off of these traders. We don’t want it legislated as such: taking the other side of these trades is like being a casino operator, while someone else is popping in quarters at your slot machines. I’ve heard colleagues refer to stocks like GME 0.00%↑ as a “fixed income money pit”, meaning they consider these “retail favorites” to be a source of income: a surefire way to make money off of emotional traders.
If any of this hits close to home, I can’t apologize. I just hope that you’ve had good trades so far, and that you’re willing to do some introspection. Are you willing to work a few extra hours a week, or save an extra 2-3%? That would contribute a great deal more to your financial goals than trading options all day. Plus, the market is stressful. Why would you want to trade every day unless you’re being paid to do so? Perhaps this is something I won’t ever understand.
The Simple Solution: Mutual Fund Investing
I know, I know. ETFs are great. But they’re still a problem for investors. They invite behavior into investing, which wreaks havoc on returns. For most people, you want a mutual fund. (In retirement, you may want ETFs. Luckily, Vanguard can convert your mutual fund shares to ETF shares overnight with the click of a button. Awesome!)
The easiest solution is to put all of your money with Vanguard or Fidelity (or both), or at least Schwab or TD. Each of these firms has low-fee index funds where you can automate your investments. You want to put X% of your income into your investments each time you’re paid. For me, that’s about 15-20% each week. This is the only investing “strategy” that I know of that has delivered consistent and scalable returns for millions of people. The only requirement is that they have the discipline and fortitude to keep their bad behavior away from their investment portfolio.
You can set up automated investing for any amount with mutual funds, and not worry about paying the whole spread on a partial share or incurring any trading costs. Federal law provides that you will receive exactly your money’s worth. There’s no such guarantee when it comes to ETFs.
Let’s take a quick look at this quote, from Nick Murray’s guide for Behavioral Investment Counsellors. He’s my my favorite author on the subject:
Giving up 60% of your money should be something you say “NO” to. Now is where you can learn how this can (and likely will) happen to you, if you’re not prepared.
Whether you’re chasing performance, falling victim to bull market euphoria, or panicking out of your investments and capitulating at the worst possible moment (and trust me, this is usually the exact moment when most people capitulate: right before a market turnaround), you’ll inevitably miss out massive gains, particularly near market bottoms.
Just this past month, we saw a final capitulation before the market took off and began a relentless march upward. I’ve already seen plenty of tweets from those who’ve missed out, and I don’t know how to help those people. I just hope they put their money to work and stop watching what the market’s doing!
Your best bet is to find a plan that involves as little work as possible, so that you can focus on the rest of your life. You can always pick up a side hustle or cut costs to add more to your investments. The idea of quick and easy money, earned through sheer brilliance and brainpower/research/charts, is a myth perpetuated by Twitter fraudsters.
Find out how to set up automated investing. Fidelity will reimburse all your transfer costs if you ask them, and always will reimburse them if you transfer 25k or more in assets to them. From there, it’s always free to transfer your assets between Vanguard, Fidelity, and IBKR. I prefer Vanguard for mutual funds, and Fidelity is second. Fidelity is best for ETFs and partial shares, while IBKR is best for financing.
If you have a taxable portfolio, it may make sense to hold it at IBKR. This is when holding ETFs makes sense. Just don’t touch them. Instead, borrow against them when it makes sense to do so. If you can avoid selling them for long enough, you’ll be able to pass them down to someone else and eliminate all the taxable gains.
But I’m Special! I only use X% of my money to trade X/Y/Z options!
Shut the fuck up. No you’re not.
You probably keep adding money to that “X%” whenever you lose, rather than shutting it down. I’ve never met an options trader who realizes they were subtly underperforming and simply quit trading options. If it’s only 2% of your portfolio, then 98 cents of every dollar earned needs to go into the REST of your portfolio.
This goes for regular income and money you earn from trading options. So you say you’re a big-time winner? Congrats. You went over X%. Time to put the extra amount into your diversified mutual fund!
If you can, you should stop trading options. They’re really not meant to be traded. Some of the most well-placed options trades expire worthless, after serving their purpose. They’re meant to be used for insurance, and by professionals. There’s an awful lot to learn, but learning it all isn’t enough to make it better than simply holding a diversified mutual fund.
If you can’t quit, it’s probably healthful to simply admit that you’re addicted. The rest of it is various amounts of copium. Yes, this includes your twitter posts and other social media activity. I’ll never tweet about it when I make a successful options trade. I either won’t notice it, or I’m too busy putting my money to work in my REAL portfolio. If I wasn’t a professional and privy to so much corporate info, I can’t imagine I’d trade any options at all.
That said, addiction is tough, and it’s real. If you can admit to it, but you can’t stop, at least try your hardest to be disciplined about ensuring you stick to the 2% rule (or whatever rule you have). If you don’t have a rule, then make one. Put 98% of your investments into a Vanguard or Fidelity mutual fund. Remember to rebalance. This means that you’re either a profitable options trader who’s putting their profits into a low-fee fund, or you’re slowly losing your 2% until you have nothing left. As long as you keep your options losses/gains separate from the rest of your portfolio, it’ll never truly be “separate”.
Choosing a Fund (That You Can/Will Live With)
There are more mutual funds than there are listed stocks. This can lead to investors trading mutual funds, and is often referred to as “performance chasing”. Anyone who’s met an ARKK 0.00%↑ investor who didn’t buy into the fund until February 2021 knows one of these people. You wanted to be selling in February 2021, and buying literally any other time. That said, they charge 0.75%/year. That’s far too much.
Choose a fund that costs, at most, 0.25% or 25 basis points a year. This is the cost of Schwab’s Fundamental Large Cap fund, and the most you should pay for a passive fund. If you prefer an actively managed fund, find one that you can stick with, such as $DODGX, Dodge & Cox’s Stock Fund, or one of Vanguard’s many actively managed funds. Avoid Fidelity, they charge far too much for active management
As a general rule of thumb, index funds should cost less than 0.10% per year. Passive, non-index funds should cost less than 0.32% per year. Actively managed funds should charge less than 0.5% per year, ideally closer to 0.3%. It’s okay to pick an actively managed fund, although I’d recommend avoiding “growth” funds or funds that aren’t properly diversified.
Use Morningstar Premium to read about funds, but know this one important fact: The #1 indicator of future performance for mutual funds is cost. Out of all the factors, cost is the primary determinant of fund returns. The top-performing funds usually become the worst-performing funds, and often the reverse happens. Go for low-fee funds from established companies that invest in a diverse number of companies (500+ ideally, but at least 100 or so. 750+ for international funds).
This is why it’s best to just pick an index fund that tracks the S&P 500 or Total Market Index. They’re self-healing and always adjusting. SPY 0.00%↑ also benefits from a light touch of “active” management, as firms must be profitable enough to gain entry. Unfortunately, they also require firms to be US Domiciled, unlike QQQ 0.00%↑. These issues will be found in ex-US funds like VXUS 0.00%↑ and VEU 0.00%↑, or global allocation funds like VT 0.00%↑.
Remember when META 0.00%↑ plummeted? That’s fine. I kept the same amount of shares, but far less of my money started going into it. Everything was going down, and #SPX trackers always buy in proportion. This is a service that normally costs quite a lot of money, but is done for free thanks to the S&P.
Today, META 0.00%↑ occupies 50% less of an #SPX portfolio, and the same goes for companies like NFLX 0.00%↑, which is by design. This is why index investors are able to sleep at night while ignoring daily market perturbations. Index funds are incredible, as they harness the collective intelligence of all market forces while nearly eliminating trading costs and other friction. This generates reliable returns for the largest amount of investors at the lowest possible cost with a minimum of trading. Anything else would be mathematically impossible.
(Total returns to all market participants must be split evenly among all participants, before fees/taxes/etc. This is why keeping your fees/taxes/”etc.” to a minimum is a sound investing plan.)
Do You Need An Advisor?
You would probably benefit from an advisor, especially if you have over $200k invested. You may prefer a behavioral investment counselor, who can assist you with finances AND address behavioral issues. As a BIC myself, we’re the person you call when the sky is falling, when you think the market can only get worse.
We’re the ones who tell you that everything is going to be fine. I’d tell you to think about buying extra stock. I’d never let you sell, I’d rather lose you as a client. If you asked me if you should sell for fire sale prices, I’d probably laugh at you. No. The answer is always no. We’re going to be fine. We’ve survived so much worse.
Imagine if you paid $500,000 for a property and had it assessed at $500,000, too. The next day, someone comes along and offers you $300,000. Then someone offers $250,000. Then another person offers you $200,000. You see someone sell a nearly identical property… for $200,000! Then the buyer approaches you, and says she’ll give you an extra $50k: $250,000 to buy your property.
This is what Mr. Market does. Each day, it tries to match buyers and sellers. To do that, it needs to change the prices around until it can find people who agree. You want to be the person who’s buying the $500,000 property for $200,000. You’d even want to be the one who offered someone an extra $50k to part with their $500k property! You know you’ll still make a nice 60% profit!
An advisor can offer you peace of mind, and reduce your stress. For the amount of money people spend on various financial tools, taxes, and other fees, I’m amazed that many won’t even consider an advisor. To some, the mere thought is an insult.
I’ll leave things there for now, and hopefully I can go into detail about some behavioral issues more in the future. But for now, I’ve realized that most people don’t realize or don’t want to recognize that their own behavior is standing between them and their retirement.
We all need to learn to get out of the way… of our own portfolio. Sometimes, we’re our own worst enemies.
With love,
💕Avery💕
Addendum: FinTwit “Calls”
A brief note on FinTwit “calls”, and my own culpability:
I’ve timed the market numerous times before. I regret it.
I’m at least partially guilty: I went to cash on February 21st, 2020, and posted about it. Rather than simply announcing “I WENT TO CASH, THIS MARKET IS TOAST”, I talked about a Discord “stocks chat” I was a member of, and complained about how it was negatively affecting my performance.
I didn’t believe the CV19 narrative, and thought our health officials were lying to us. Sometime in late January, I began getting very worried that the market wasn’t reacting. I told myself that “if I see people wearing masks in Times Square on the front page of the NY Times… that’s when I’m getting out”. And so I did.
I told my “friends” on Discord. They all took turns making fun of me, posting images of Warren Buffett saying “BTFD!” and generally being unhelpful. At least I’m a professional. The market went on to drop a further ~25%. I was holding QQQ 0.00%↑ , SPY 0.00%↑ , ARKW 0.00%↑ , ARKK 0.00%↑ , TAN 0.00%↑ , and PBW 0.00%↑ . Pretty speculative stuff.
When I saw the market going red in a bad way, I checked the NY Times. Sure enough, there were photos of Americans wearing masks. I checked my portfolio, and saw my speculative names dropping… down -3%… -4%… -5%. Something was wrong. I quickly sold everything. I went to my 401k, and moved all of my funds from the Vanguard 500 VOO 0.00%↑ to cash.
I successfully dodged the crash, and started putting shorts on energy and transportation/travel names. I was able to get back into the market near the lows. I re-bought QQQ 0.00%↑ and ARKW 0.00%↑ and ARKK 0.00%↑. I even grabbed some AAPL 0.00%↑ and AMZN 0.00%↑.
This is one of the most difficult things I’ve ever done, and I regret it. The people in Discord were actually right. Sure, I timed things well, but I invited so many potential problems and could’ve missed out on 20% of upside following the big JPow speech.
Getting back into a market once you’ve pulled your money can be one of the most stressful and difficult things you’ll ever have to do. Avoid pulling your money out in the first place. Instead, ensure you don’t have too much allocated to equities that you can’t emotionally handle a drawdown without your behavior causing problems. Remember, your portfolio is going to be fine without you.
By the time you retire (in hopefully 20+ years), just assume the market will be much higher, because it will. That’s how capitalism works, and the US is the largest investable capital market in all of history. Taxes on long-term investments are miniscule compared to income, and they’re 0% for anything you can pass down to you successors.
Let’s say #SPX 7500, just for fun. If we could know that the #SPX would be at 7500 when we retire (we do have a good idea that it will keep going up along with GDP), then who cares if it’s at 3970 or 4500 now? Who cares if it goes down some before it goes up?
Your goal should be to accumulate as many shares of your mutual fund(s) as you possibly can. This may mean knuckling down and investing more and more as the market gets cheaper. You just need to have the faith (or knowledge?) that the market will eventually get better. It’s always scary, and it will be again. All you can do is be prepared and ensure you don’t mess it all up.
Keep contributing regularly, and everything will be fine.
Signing off a second time now. Diversify, automate, and prosper!
-Avery💕
Lasting reading of the economic numbers suggests rates going higher for longer. I had thought a Macro trader going long TLT/TMF and short SPY would be the right trade for 2023. Neither side seems to be working yet. Besides raising cash and treasury notes, I don't see much opportunity out there.
You don't discuss MACRO trading or I haven't found it on your commentary. For example I believe we are closer to the end of the rate hike cycle and expect to see a real market bottom in Q1-23 as the Fed begins to pivot. $ will fall and anticipation of lower rates will ignite a strong rally in emerging markets. I want to build positions for that.