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.
? Overconfidence. Once they’ve had some success, investors start to think they have everything figured out. In that state of mind, they’re less aware of the risks they take. They keep throwing the dice, sure that their bets will eventually pay.
If they lose, they ascribe it to bad luck or the actions of others, not to bad choices they made themselves. So they trade again.
? The illusion of knowledge. Online investors have access to huge amounts of financial data. The more they know, the more they believe in the rightness of their investment views. “You’ll make more because you know more,” one provider of data blares.
But data don’t confer knowledge. Confidence rises faster than performance does, and you already know what overconfidence can do.
? The illusion of control. You think that if you “take control” of your investments, everything will come out all right.
And you’re certainly in control, when you surf the Web for stock ideas and place your own orders to buy and sell. But blowing on the dice doesn’t raise the odds that your number will come up, and neither does your hand on the mouse.
? Misunderstanding trading costs. Investors know what commissions they pay, but they may not know how much money they lose on the bid-asked spread.
At any given moment, the price you can get when you sell a stock (the “bid”) is lower than the price you’d pay if you bought (the “asked”). The difference goes into the broker’s pocket and out of yours. Small stocks have wider spreads than big ones, and online traders are usually spinning smaller stocks.
Online accounts are convenient and levy lower commissions than traditional accounts do. If you switch and don’t let your mouse finger get trigger happy, you could come out ahead.
The truth (you should say to Fidelity and the rest of the gang) is that the quick die first. You know the conclusion by heart, even if you don’t want to hear it: You make more money by buying stocks and holding them.
Traditionally, your pay has depended on real things: your line of work, seniority, performance and expertise. But not anymore at least not in the white-collar world.
Nowadays, compensation feels more like a lottery. You might, or might not, luck into a job that gives stock options. The options might, or might not, pay off.
Employees with traditional pay get modest raises. The consulting firm William M. Mercer thinks that average salaries will rise by around 4 percent next year.
Employees with stock options might luck into giant paychecks. Of two people doing exactly the same job, at two different companies, one might get average pay while the other gets rich.
A recent Mercer survey of 350 leading midsize and large companies found that 17 percent now grant stock options to all of their employees. Five years ago, only executives could get them, says Mercer principal Steven Gross.
Gross thinks the trend will continue. “Companies are using stock options as currency,” he says. With a good options package, workers especially young ones may be willing to work for lower pay.
An option gives you the right to buy a certain number of company shares, at some point in the future, for the price of the shares on the day the option grant was made. For example, say you receive 200 options on a $20 stock. The stock goes to $50, and you “exercise” the option (meaning that you cash it in). You’ve made $30 a share, for a $6,000 profit.
If the stock price goes down instead of up, your options normally expire worthless. So you’re taking a risk.
In fact, owning options is turning employees into worried stock-market timers. If the stock price goes up, should you exercise your options now? Or should you wait, hoping the price will rise further?
If you wait and it rises, you’ll be thrilled. But if it declines, you’ll be miserable. You may have to exercise the options at a lower price.
Of the firms that grant options to all employees, nearly two-thirds are in high-tech businesses. Recently, more traditional firms have gotten into the game to attract good employees.
If you don’t get options, the compensation lottery might bring you a bonus. Of nearly 2,000 midsize and large companies surveyed by Mercer, half have increased the number of employees eligible for performance incentives.
But don’t build bonuses into your permanent budget. Bonuses fade when profits do.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.