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Thanks to the Internet, it has never been cheaper for individual investors to trade stocks. At the same time, average quarterly trading volume on the Big Board has more than doubled over the last three years. Coincidence? Or is the steep drop in commission costs encouraging individuals to trade more than ever?
A recent economic study strongly suggests it's the latter. The results of the research paper, "Does the Internet Increase Trading? Evidence from Investor Behavior in 401(k) Plans," by economists James J. Choi, David Laibson, and Andrew Metrick, is significant from a macroeconomic perspective. The easier it is for investors to buy and sell stocks, the better the financial markets allocate capital away from unprofitable activities into more promising opportunities.
But from a micro point of view, the implications of the authors' analysis are disturbing. The surge in trading they highlight takes place in retirement-savings plans, an investment vehicle that rewards patience and long-term thinking rather than wheeling and dealing for a quick buck. (You can get their article, Working Paper No. 7878, at www.nber.org.)
QUICKSILVER SPEED. The authors' evidence is striking. They investigate the impact of Web-based trading by gathering data from two corporate 401(k) plans with about 100,000 participants. Both companies opened their Web-based channel to the stock market in August, 1998. After adjusting the raw data and comparing trading growth patterns to a sample of corporate retirement-savings plans without a Web channel, the scholars calculate that trading activity nearly doubled with online access. Daily turnover, which is the fraction of balances traded, rose more than 50%.
Yet there's no evidence suggesting that all this activity pays off, and there's abundant evidence that a disciplined, long-term approach with minimal trading increases the odds that investors will reach their long-run financial goals. For instance, economists Brad Barber and Terrance Odean at the University of California at Davis looked into the stock-trading behavior and investment performance of more than 1,600 investors who switched from phone-based to online trading from 1992 to 1995. Big mistake. Individuals who made the switch traded more actively and more speculatively than before, and their returns went from beating the market by an average of 2% to trailing it by more than 3% annually.
It's tough to beat the market, whether trading online or through a broker. Investing is the most competitive business in the world. Markets move at quicksilver speed in a global economy linked by computers, satellites, and fiber-optic cables. It's remarkably difficult to systematically gain an investment edge on everyone else.
"SEEING EYE." To be sure, just as there are great painters, novelists, pianists, and basketball players, so there are investors who combine patience with unusual talents and insight, such as Warren Buffett. Here's how Barton M. Biggs, a longtime observer of markets and a global investment strategist at Morgan Stanley Dean Witter, describes top-notch investment talent: "They must have some special magic with the markets that enables them almost intuitively to do the right thing, buy the right stock, far more often than ordinary investors. They have what Churchill called the 'seeing eye...that deep original instinct which peers through the surface of words and things -- the vision which sees dimly but surely the other side of the brick wall or which follows the hunt to fields before the throng.'"
Yet how many investors in a 401(k) plan are possessed with the "seeing eye" when it comes to picking stocks or mutual funds? Not many. Individual investors who trade stocks by the hour or the week, or those who move in and out of mutual funds several times a month or quarter, are wasting their time and money.
Farrell is contributing economics editor for Business Week. His Sound Money radio commentaries are broadcast on Saturdays in nearly 200 markets nationwide Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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