Your Self-Inflicted 6% Trading Tax

How Not To Make Money

Making a turn from the markets is hard, we all know that.  Unfortunately we tend to make it a lot harder for ourselves than we need to, and if we don’t then the investment industry is always there to lend a helping hand.  For an extortionate fee, of course.

We’ve already looked at the gross amount of money we conspire to lose each year – something in the region of $160 billion a year in the US alone (see: The 160 Billion Dollar Bezzle).  Now a UK writer has looked at what this means for us as individuals.  The answer is, very roughly, a cost of 6% a year.  Which, when the average return from the stockmarket is probably no more than 5%, makes for a not very good way of making money.

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Are Traders Dumber than Drooling Dogs?

Salivating Spaniels

Given the ebb and flow of investor sentiment, often for no other apparent reason than the ring of the opening and closing bells of the market, it’s terribly tempting to compare traders to the salivating dogs from Pavlov’s famous experiment.  The dogs, of course, were trained to salivate at the ring of a bell in the expectation of a good meal.

Naturally, this would be demeaning, a gross insult to the intelligence of our canine friends.  Because it turns out that there’s quite a lot of good evidence that humans investors are, despite their superior intellectual capabilities, dumber than drooling dogs.

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The Small Cap Trap

Rampaging Elephants

The theory is that small capitalization stocks offer great rewards. After all, as Jim Slater pointed out in The Zulu Principle: “elephants don’t gallop”. Well, apart from when they’re being chased by a psychopath, armed with an elephant gun, in a bulldozer. As the last few years have shown, even behemoth sized corporations can grow startlingly quickly if they’re priced to go bust and then get bailed out by obliging governments.

Still, the idea that smaller cap companies offer outsized rewards is hard to shake. To the extent that share price grows with earnings then it ought to be easier to double the price of a small company than a large one. Which is, more or less, true. The only trouble is that it’s probably more likely you’ll see it sink to zero.

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Survivorship Bias in Magical Mutual Funds

The Magical Inflation of Mutual Fund Returns

Despite years and years of data showing that, on average, actively managed funds underperform their passive brethren by around the amount charged in fees – a point William Sharpe demonstrated using the most basic math back in 1991 (The Arithmetic of Active Management) – the darned things won’t lie down and be slain. Worse still, they use their excess fees to dream up smart new ways of improving their apparent returns.

Perhaps the cleverest and simplest method is to magically make the worst performers disappear from the record, a clever trick I wish I could perform with my portfolio. However, just like the investors in those disappeared funds, I’m stuck with my returns while the funds benefit through survivorship bias.

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