Tequila, Handguns, and Even Costlier Mistakes

"A computer lets you make more mistakes faster than any other human invention in human history ... with the possible exception of handguns and tequila." -- Mitch Ratcliffe

Fortunately, for me, the mistakes I've made from that list have been limited to those involving computers and tequila (though never at the same time). But it's a pretty good quote. It's one that investors should definitely keep in mind, though there's substantial evidence that as a group, they do not.

The stock market is a wonderful place -- one that has historically provided investors with approximately 6.5% to 7% real annual returns. That's after factoring in inflation -- though not factoring in the costs of investing.

Enough about tequila
Those costs are a big part of what, ultimately, can be so, so, so darned expensive. At least the way the majority of Americans seem to invest, which is through managed mutual funds, a costly financial advisor, or all-too-active trading. Vanguard founder Jack Bogle estimates that the annual costs of trading and investing are around $350 billion annually. Stunning.

Let's examine how so much extra money is sucked up by our financial system so quickly -- and then point our fingers at those darned computers, which are at least partially to blame.

Eight years ago, when Warren Buffett calculated that the annual costs to investors were $130 billion (figuring in trading costs, mutual fund management fees, and other enumerated fees), he wrote that this is "a horrendous cost." Buffett continued:

"I heard once about a cartoon in which a news commentator says, 'There was no trading on the New York Stock Exchange today. Everyone was happy with what they owned.' Well, if that were really the case, investors would every year keep around $130 billion in their pockets."

To illustrate, let's look at a typical day. Here's what the most active trading for the markets looked like yesterday:

For those 10 stocks -- actually seven stocks, and three tickers that essentially are just trading vehicles (the three depository receipts) -- about 685 million shares were traded.

Now, yesterday was a pretty decent day for the market. The Nasdaq Composite was up 0.66%, the S&P was up 0.64%, and the most-traded stocks as a group performed slightly better than the indexes. But those movements are essentially just reversals of losses from equally large trading volumes last week and in the past few days. All we've really done is watch is a pretty expensive round trip over the past few days.

Back to costs
The total costs of trading those 685 million shares was approximately $41 million (assuming about $0.06 per share to trade, according to Buffett's old math). And that's just a small fraction of the market for a single day. It also doesn't begin to factor in the tax costs.

And this rapid switching of chairs has been made possible, and almost impossibly easy, by -- you guessed it -- the computer.

The trading volume over the past 10 years has moved up rapidly -- but all that trading does not improve the returns to investors. Far from it. All those trading costs, and it comes directly out of the returns investors can actually pocket.

A different method
The availability of high-speed connections and discount brokers has made the rapid trading of shares easier and cheaper than possible. So cheap, in fact, that people make the mistake of doing it all the time and incurring huge costs.

The accumulation of wealth through the stock market is achieved by actually researching companies, buying them, and holding on for a while. "Years," in fact, is the average holding period for the few consistently successful mutual fund managers. Peter Lynch has said that the best returns for the companies he bought for Fidelity Magellan, where he racked up incredible annualized returns of 29% over his 13-year tenure, occurred five years after his initial purchase.

I'm guessing most of the people trading in and out of the list of stocks I mentioned earlier have not owned the shares for five years. Am I'm also going to guess that most of them aren't beating the market.

Use your computer wisely
Think about that the next time you get an itchy trading trigger finger. And if you're looking to enjoy the profits of investing in businesses for the long term rather than trading stocks for the very short term, join us at Motley Fool Stock Advisor.

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Bill Barker does not own shares in any of the companies mentioned in this article. Intel, Pfizer, and Microsoft are Motley Fool Inside Value recommendations. The Motley Fool has a disclosure policy.