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 measures 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.
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. These days, 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 mobile phone, I can check news on my stocks while I'm walking to the gym (if I were the kind of person who went to the gym). I can then use my brokerage's mobile app to trade a stock while using 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 discloses statistics on its clients' trading activity. In the online broker's annual reports, there's a data point called "Average client trades per account, annualized." In 2005, that number was 11. In 2009, it was up to 12.9. And in last year's report, it hit 17.4.
The trend is clear. 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 customer "averaged one trade per quarter" during the 1990s. In the first quarter of 2000, that had nearly tripled to 2.8.
When it's both cheap and convenient to trade, the likely outcome is ... more trading. We can thank technology for that, but this trend started 40 years ago this week. Let's turn to Michael Lewis' classic 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 brokers such as Morgan Stanley reacted by moving heavily into mergers and acquisitions 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.
That's not a knock on the business models or business practices of TD Ameritrade, Schwab, and the rest. I'm a customer of their services myself, and have looked at this industry more than once for investment. (Full disclosure: The Motley Fool has 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 might not always be in sync, and that technology and 24/7 trading account access can often lead to too much "excitement." For a more eloquent way of saying it, here's Warren Buffett from the 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 gain returns that will help you achieve your financial goals, you'll need to keep excitement and expenses in check -- tough work with Twitter, 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:
- Know yourself. Create an investor policy statement (print one here), make sure your investment strategy aligns with your timeline, risk tolerance, and values, and stay true to yourself along the journey.
- Keep a journal, online or off, that lets you log your thinking on every buy/sell decision you make. New York University Stern School of Business professor Aswath Damodaran once 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.
Brian Richards does not own shares of any companies mentioned. This is an updated version of an article originally published in 2010. The Motley Fool owns shares of Berkshire Hathaway and TD Ameritrade. The Fool has a disclosure policy.