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Does a Fund's Excessive Trading Hurts Investors? By How Much?

6/26/2014

1 Comment

 
Q. How to measure a fund's trading cost's impact?

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!

Hypothesis
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!
1 Comment
Epicresearch link
8/13/2014 08:26:01 pm

It makes me so satisfied due to your vast understanding and wisdom have a new channel for trying into the world.

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