A. We all know a fund's high expense ratio hurts, but does excessive trading also hurts?
Excessive Trading Hurts an Investor
In 2000, two professors at UC DAvis published a groundbreaking paper in the Journal of Finance - "Trading is Hazardous to Your Wealth", they got access to over 66,000 customers' records and found that people who traded the most averaged returns that were 30% less than those of the average customers and 36% lower than the stock market itself!
Researchers naturally suspect a fund that engages in excessive trading might also hurt its performance. While it's easy to quantify a fund's expense's impact on return, it's hard to measure the trading costs' impact.
A Fund's Trading Costs
Nevertheless, it's possible to breakdown a fund's trading costs into the following categories:
- Brokerage commission costs (yes, funds also have to pay such costs, at different scales)
- Bid-ask spreads (pay more than the actual trading price to buy a security and get less to sell it)
- Price impact (when a fund unloads a position, it drives down the price; when a fund loads a position, it drives up the price).
Proxy to Excessive Trading
The best proxy to trading cost impact is probably a fund's turnover rate, which is reported annually by every fund. A fund that rarely buys and sells has low turnover (and low aggregate trading cost).
For ordinary investors, the best strategy is probably buy and hold, or find a buy-and-hold fund managers, or simply buy-and-hold an index fund for the long term!