Commission Free Trading In A Volatile Stock Market… Ouch
Last October, in a race to the bottom, the major discount brokerage firms (Schwab, Fidelity, TD Ameritrade, and E-Trade) eliminated commissions on the majority of stock trades. Whether they were planning this move or not, it was definitely accelerated by the market disruptor, Robinhood Financial, where trading fees have been nonexistent since the firm’s inception (to my knowledge). How this impacts the brokerage firms, we’ll leave that to another day. The question now is what has this done (is doing) to the individual investor? Insert a crisis and your answer appears… sooner rather than later.
As advisors who look to make lifetime investments our trading activity skews to the low side as we are willing to ride out the highs and lows of stock volatility for the reward of long-term gains. This is a behavior lost on many individual investors… especially when the going gets tough (i.e., volatility appears). Their solution… more activity! The likely
outcome… not what you want to hear.
For the quarter ending Dec 31, 2019, TD Ameritrade saw it’s average daily client trades hit one million… a record for their firm. Fast forward three months and for the first quarter of 2020, that metric more than doubled to 2.1 million average daily trades! I guess records are indeed made to be broken, but just because something is free, it doesn’t mean you have to indulge.
Yes, the stock market correction in March prompted even us to make more trades then we typically do… but double the trades?!?! Even before the free trading era, more activity for the typical individual investor does not lead to the desired results. Many factors lead to underperformance, but most damaging is the time out of the stock market.
A volatile stock market, drives uncertainty, which in turn accelerates an inexperienced person’s “fight or flight” or fear gauge. When we are fearful, our ability to make sound decisions may escape us and we forget why we invest in the first place… long-term capital growth. Thus, many individuals will seek safety, sell their stocks and sit out the volatility. Well, you might miss some downside, but you will also miss any upside.
For the last two decades, the more of the stock market’s best days that you miss, the worse your performance. This is only logical. But what will leave you shaking your head, is if you only missed the 10 best days over the past 20 years, your annualized performance is more than cut in half! If you stay fully invested in the S&P 500 Index
from 2000 – 2019 your annualized return is 6.1%. Sit out the 10 best days and that annualized return drops to 2.4%!
It is suprising to us that the elimination of trading fees (as low as $5.99) would spur more trading, but it appears to be the case. Apply this history to the free trading era and I’m fearful the level of underperformance we might see. I guess time will tell. In the meantime, let’s put it this way. Just because there is no cover charge at the night club, Club Wall Street, does not mean you should keep coming and going. Even when a bad song comes on… stay awhile so you don’t miss out when things turn up.
Note: Nothing contained herein this letter should be considered to be investment advice, research or an invitation to buy or sell any securities.