Too much buying and selling activity – let alone day trading – has long been associated with poor investment performance.
Sure, some high-frequency robot raiders make a killing buying and dumping shares faster than you can say, “Hmm, does that quote include the decimal point?”
For the average investor (that’s us), over-trading usually means higher transaction fees and potentially higher taxes.
But even more importantly it causes you to focus on wringing short-term returns from your portfolio, when thinking long term – i.e. about the businesses we invest in, and our own financial goals – and being patient is the surer route to investing success.
And there’s a hidden psychological reason why you shouldn’t churn your portfolio like a market trader trying to get rid of the day’s ever-smellier fish, too.
It seemed a good idea at the time
Have you ever come back from the January sales with a ridiculous item of clothing in tow?
You went in to secure that expensive jacket you’ve had your eye on for months that’s finally in your price range.
Perhaps you also added a well-fitting dress shirt to your haul, although you do now wonder whether it’ll get half as much wear as your original purchase.
But that is nothing compared to those supposedly unbeatable bargains you grabbed at the end of the trip – fluorescent green board shorts, a neon pink feather boa, and a novelty t-shirt you immediately relegate to the gardening drawer.
What were you thinking with those?
You might imagine you should have thought harder before you bought them. But according to scientists, the problem may be that you tried to think too much.
In the literature this phenomena of making ever worse choices is called ‘decision fatigue’. You can bet your bottom pound it applies to investors, too.
I predict disquiet
In a recent paper entitled Decision Fatigue and Heuristic Analyst Forecasts (stick with me) researchers from the University of California considered the accuracy of forecasts made by stock-market analysts.
Professional analysts typically cover many different companies. They may also have to make many predictions about them (from the direction of the firm’s earnings to the direction of its share price) over a period of hours.
And just as decision fatigue theory would suggest, the academics found that the accuracy of the forecasts the stock-market analysts made declined over the course of a day, as the number of forecasts they made increased.
That is to say, the more they forecast, the less accurate the next one tended to be.
The parallel with stock picking is obvious. Even if you fancy yourself as a short-term trader, you’d be well-advised to avoid day trading and to limit yourself to one or two actions a day – because the more you need to make decisions about further trades, the worst those decisions will probably be.
Trade too much, and you’ll end up with the portfolio equivalent of a closet full of feather boas and Hawaiian board shorts.
Take your time
Of course, we Fools don’t recommend you go in for short-term share trading at all. The evidence we’ve seen shows it’s a poor way to make money from shares.
To beat the market, you need to do something different to everyone else, you need to be right about how your portfolio should differ, and you need to hold on for long enough to see the benefits.
For us, that means looking for high quality companies trading at fair prices – and crucially having the patience to then hold on to them for the long term, so that the strengths of our businesses can shine through and hopefully make that fair price you paid look a steal.
Let’s be honest, plenty of people are looking for great companies and few want to pay more than a fair price for them. So, taking our time to decide on and secure stakes in the best companies – and then sitting on them indefinitely – could be the best edge we private investors have left.
Give your overworked brain a break! Commit to only a few companies a year, and save your decision fatigue for when there’s too many tasty choices on a restaurant menu.
