'Trade as little as possible': UBC research finds frequent stock trading leads to more risk and less reward
The TSX ticker is shown in Toronto on May 10, 2013. (THE CANADIAN PRESS/Frank Gunn)
VANCOUVER -- The sudden surge in the price of shares of GameStop and other underperforming stocks last month made some people millionaires, but it saddled many more people with losses.
As investment forums on Reddit and the growing popularity of commission-free stock trading platforms encourage more people to try to beat the market by picking the right investments at the right times, new research from UBC's Sauder School of Business urges caution.
The study, called "The Volatility of Stock Investor Returns," builds on previous research that has shown that frequent buying and selling tends to lead to lower returns than simply buying and holding.
In addition to the tendency of this "time the market" strategy to lead to lower returns, UBC researchers found that such behaviour also increases the volatility of a portfolio.
The study looked at data from the New York Stock Exchange, the American Stock Exchange and Nasdaq, calculating "dollar-weighted" returns to capture the effects of market volatility over time.
Dollar-weighted returns look at both the performance of a given stock or portfolio and the timing of investments into it.
“For example, if you inject $1,000 today, that has a very different implication than if you inject $1,000 two months from today, because the market conditions are very different, and the stock prices are different,” said study co-author and Sauder assistant professor Dr. Xin Zheng in a news release.
Zheng and his co-author, Ilia D. Dichev of Emory University, found significant differences in volatility when looking at dollar-weighted returns in comparison to "buy-and-hold" returns - that is, just the change in the price of a stock over a given time frame.
Over a 20-year investment period, dollar-weighted returns showed 50 per cent higher volatility than buy-and-hold returns did. Over 30 years, the difference was even greater, with dollar-weighted returns 71 per cent more volatile than buy-and-hold returns.
While this finding highlights the significant risks investors take on when they buy and sell frequently, it's not only such "active investors" who are affected by the higher volatility.
At the start of their paper, the researchers ask the reader to consider an investor starting from scratch and steadily adding to an investment portfolio over a period of 20 years. If returns are consistent for the first 10 years and then swing more wildly during the second 10, the investor will see greater overall volatility over the course of the two decades, because they have a larger amount of money invested during the more volatile period.
Zheng's advice for retail investors is to "trade as little as possible."
"Investors shouldn’t be on their phones constantly," he said. "They can monitor as much as they want, but trading is costly and it contributes to overall market volatility, which will affect their own stocks."