Buffett's Investing Enemies, and How to Beat Them

The faster you can go, the more dangerous the activity.

I learned this lesson the hard way, biking down a steep hill as a kid -- before helmets or hand brakes or pretty much any other safety measure were thought necessary for kids riding bikes down steep hills.

Today, the Internet is teaching the very same lesson to investors: The Web has us moving fast enough to hurt ourselves.

Still with me?
Here's how fast we move when online: If you act as an average reader would, you'll spend barely three minutes reading this article. In Shakespeare's day, brevity was the soul of wit. Now brevity is the soul of the Web, if only because our attention spans have shrunk.

This is the double-edged sword of technology. With my smartphone, I check news on my stocks while I'm walking to the gym. I can then use my brokerage's mobile app to trade a stock on a treadmill. It's fast, easy, convenient -- and dangerous, because it allows for quick trading and impulsive decision-making.

As a public company, TD AMERITRADE (Nasdaq: AMTD) discloses stats related to its clients' trading activity. Have a look:

Source: TD AMERITRADE 2005 and 2009 10-Ks. Activity rate equals average client trades per day divided by average number of total accounts.

As technology has gotten faster, investors have traded more. The difference is more dramatic if you consider earlier decades. According to a May 2000 CNET article, the average Charles Schwab (NYSE: SCHW) customer "averaged one trade per quarter" during the 1990s. In the first quarter of 2000, it had nearly tripled to 2.8.

When it's both cheap and convenient to trade, what's the likely outcome? More trading. Let's turn to Michael Lewis' Wall Street expose, Liar's Poker, for context on this phenomenon:

The stock market had once been Wall Street's greatest source of revenues. Commissions were fat, fixed, and nonnegotiable. ... A broker was paid twice as much for executing a two-hundred-share order as for a one-hundred-share order, even though the amount of work in either case was the same. The end of fixed stock brokerage commissions had come on May 1, 1975 -- called Mayday by stockbrokers -- after which, predictably, commissions collapsed. Investors switched to whichever stockbroker charged them the least. As a result, in 1976, revenues across Wall Street fell by some six hundred million dollars. The dependable money machine broke down.

Fat, fixed commissions vanished, and discount brokers popped up to disrupt the stodgy brokerage business with low-cost access to the markets. Traditional broker Morgan Stanley (NYSE: MS) reacted by moving heavily into M&As and other new business lines. Discount brokerages really did revolutionize the way we buy and sell securities, and they democratized equity ownership in the process. Time wrote in 1975 that Mayday gave investors the opportunity to "shop among competing brokers for the lowest commissions and the best services."

It would be a massive victory for Main Street investors, except for one thing: Without those fat, fixed commissions, discount brokers need transaction volume. The more actively you trade, the more money they make.

You knew Buffett would be quoted, right?
That's not a knock on the business models or business practices of TD AMERITRADE, Schwab, Scottrade, E*TRADE (Nasdaq: ETFC), ING's (NYSE: ING) ShareBuilder, or optionsXpress (Nasdaq: OXPS). I'm a customer of their services myself, and have looked at this industry more than once for investment. (Full disclosure: We have advertising partnerships with several of these companies.) They provide a wonderful service -- low-cost stock trades with first-class research and tools -- and deserve to earn profits for said service. And they're not necessarily working against investors, in the same way a beer company wants you to buy a lot of beer but doesn't want you to get blackout drunk every night.

This is simply another reminder that how they make money and how you make money may not always be in sync, and that high technology and 24/7 trading account access can cause too much "excitement." Here's Warren Buffett in his 2004 Berkshire Hathaway Chairman's Letter:

There have been three primary causes [for why investors didn't earn juicy returns despite a multidecade bull market]: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long under way) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. (emphasis mine)

What's the point?
Research has shown that trading is hazardous to your wealth. To beat the market and find returns that will help you achieve your financial goals, you'll need to keep excitement and expenses in check -- tough work with an all-day news cycle and a cheap way to trade literally at your fingertips.

So here are two old-school ways to fend off the temptation of new-school technologies:

1. Know yourself. Create an investor policy statement (print one here), make sure that how you invest aligns with your timeline and values, and stay true to yourself along the journey.
2. Keep a journal, online or off, that lets you log your thinking on every buy/sell decision you make. NYU Stern School professor Aswath Damodaran told a group of Fools that creating a record of why you made a decision, and what your emotions were at the time, allows you to develop knowledge over time. And that, in turn, can lead to a sound stock market temperament.

I'm not so dogmatic as to think it's never wise to buy or sell a stock using a smartphone on the go. But low-cost trading has an ugly side -- overtrading based on emotion/excitement, causing unnecessarily high trading costs and taxes. Those are enemies worth fighting.

Fool.com executive editor Brian Richards does not own shares of any companies mentioned in this article. Schwab and Berkshire Hathaway are Motley Fool Stock Advisor recommendations. The Fool owns shares of Berkshire Hathaway, which is also an Inside Value pick. The Fool has a disclosure policy.