There is a big downside to the holiday season: We tend to eat too much, drink too much and get lazy. Oh, and closed stock markets thwart any thoughts we might have of trading stocks.
When both the Toronto Stock Exchange and the New York Stock Exchange closed for Christmas and New Year’s Day – with a shortened trading day on Christmas Eve and a Canadian Boxing Day holiday thrown in – investors were forced to sit on their hands for an unusually long period when news develops or they happen to think of a good stock pick.
But rather than complain, investors should sit back and relax with another beer and bag of chips. For most people, a closed stock market is a good stock market.
A number of studies have demonstrated that trading does the opposite of what it attempts to achieve: Rather than putting investors in better money-making opportunities, trading tends to lose money or at least depress overall returns.
Brad Barber and Terrance Odean, finance professors at the University of California (the former at Davis, the latter at Berkeley), demonstrated this in a paper published in the Journal of Finance in 2000.
They peered into the trading activity of 78,000 households at a large discount brokerage firm between 1991 and 1996, and found that the most active traders trailed the stock market’s performance by 6.5 percentage points per year.
That’s a stunning underperformance, especially when you consider that it was caused by doing too much: These active traders turned over their portfolios by an average of 250 per cent a year, meaning that an entire portfolio was ditched and recreated every five months.
Doing nothing – otherwise known as the buy-and-hold approach – yielded far better results. No wonder Mr. Barber and Mr. Odean entitled their paper “Trading Is Hazardous To Your Wealth.”
They blamed excessive trading on overconfidence, or the feeling among some investors that they have an edge on the market because of their superior knowledge or gut instincts.
Too often, these investors have neither. Excessive trading also racks up costs and gives far too much power to one’s emotional impulses, both of which can hurt your portfolio.
But too much trading can just as easily be blamed on too much opportunity. Throughout the day, anyone can buy and sell with the click of a mouse – often in reaction to volatile market moves and headline-generating news about elections, economic reports and earnings surprises.
It is only when markets are closed that investors are saved from this dangerous temptation.
Warren Buffett, the world’s greatest living investor and the source of some of the most sensible investment advice, has long praised the virtues of long-term investing and has made it clear that he doesn’t fret about the holidays.
“Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years,” he said.
Admittedly, a 10-year break from tinkering with your portfolio does sound a little extreme. But a few days off here and there? The occasional break is just what your investment portfolio needs.