JANE BRYANT QUINN
The ads you see for online trading are, um, kidding you.
They make you think that the faster you trade, the more money you'll make. "The slow die first," Fidelity Investments whispers in your ear. But frequent traders simply pay more money to their brokerage firms.
If a full-service broker traded your account that fast, you might complain that you were being illegally churned. The online brokers, cleverly, get you to churn your account yourself.
The more you trade, the less money you make, as several academic studies have already shown. Now there's fresh evidence from finance professors Brad Barber and Terrance Odean of UC Davis.
They studied the performance of 3,214 investors with accounts at a discount brokerage house. All picked their own stocks. All had accounts of a similar size. Half switched from telephone investing to investing online. The other half didn't.
What motivated the first group to make the switch? Probably their investment results. On average, they were outperforming the stock market. By trading more, just as the zippy ads exhort, they expected to pile up even bigger bucks.
In any random collection of stock-market investors, some will beat the market for a while. Inevitably, they attribute their good results to personal genius rather than to random luck. And why should a genius hold back?
So they open an online account, and churn their money. Prior to switching, they turned over 70 percent of the stock in their investment portfolios every year. In the first month after the switch, their turnover rate leaped to 120 percent.
Two years later, their turnover rate still averaged 90 percent a year. Their turnover rate nearly doubled for purely speculative trades, by Barber and Odean's measure. By contrast, the people investing by phone were turning over their money at an annual rate of just 50 percent.
What did the online traders get for all their fancy investing? Poorer returns than they got before. Before costs, they roughly matched the market. After costs, they under-performed by an average of 3.5 percent a year.
They may have thought they were still doing great, because their accounts were going up. But they weren't going up nearly as fast as they did before.
Four main things motivate investors to go online. They're led there by ads that go "right to the emotional centers of the brain," Odean says. The same feelings lead them to trade more rapidly, which undermines their hopes.
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