The Twelve Rules of Investing, Rule #8: Don’t Trade Too Much

Posted on Posted in Financial Blog

Excessive trading (buying and selling) reduces your return in three ways: transaction costs, taxes and bad timing. Each time you make a trade, you may incur transaction costs and taxes (which are higher for short-term trades). Bad timing (buying high and selling low) further reduces your return.

How much does excessive trading hurt your returns? A study in the Journal of Finance showed that the most frequent traders earned almost 7% per year less than those who traded least often. (The study was done in the 1990’s, when the average annual return for stocks was +17.9%.) Earning 11% per year isn’t bad, but it stinks when the market is generating nearly 18%!

In any market environment, excessive trading is bad for your fiscal health. When in doubt, doing nothing is often the best course. (But don’t hold on to your losers too long: see Rule #3.)