Could A “Transaction Tax” Be A Good Thing?

Could a “transaction tax” be a good thing?

I recently discussed why “Free, Isn’t Really Free” regarding the retail investor. While “free trades” have certainly reduced the transaction costs, the selling of data to the highest bidder has likely cost investors more than they saved. To wit:

As is clear from the billions paid for order flow and the billions made from executing those orders, there is no such thing as ‘free trading.’ Thus, the claim of ‘commission free trading’ is often no more than a rhetorical ruse to attract new investors and distract from the billions of dollars in PFOF and other hidden costs that ultimately come out of retail investors’ pockets. It’s pretty clear that these intermediaries are often merely transferring the investors’ visible upfront commissions into invisible after-the-fact de facto commissions.”

However, there is another problem with “free trading” that will likely reduce your investing outcomes over time.

 

It’s A You Problem

Over the years, I’ve heard from several clients who have had trouble disciplining themselves from trading too frequently. That was in a low-cost world.

Now that trades are no-cost, it’s going to get a lot worse.

It’s difficult enough to match, much less beat, stock indexes without the drag of frequent trading. Frequent traders, from my experience, rarely do well in the stock market.

Kiplinger article noted the same.

In one study, Odean found that trading costs did indeed weigh on the performance of investors who traded more frequently. Such is a problem that no-commission accounts will render obsolete.

But no-commission trades won’t do anything about the results garnered from another study. Odean found that, ‘on average, the stocks these investors bought went on to underperform the stocks they sold.’

Speculative trading (trades that didn’t seem driven by, say, tax purposes or rebalancing concerns) was even worse. Across all trades, stocks that investors bought underperformed those they sold by three percentage points. However, that disparity widened to five percentage points when considering only speculative trades.

The zero-commission trade is bound to amplify the low-cost proposition of exchange-traded funds. By accelerating the huge migration of investor dollars away from actively managed mutual funds. Now, if investors simply stuck to buying broad-based index ETFs and holding them, that actually would be a good thing.

But what’s far more likely is that a big swath of these investors will trade more. They will try to pick ETFs and stocks that will beat the market over short time periods. After all, the trade is free – why not make it?”

Psychological Drag

So free trading may save you money on trading costs, but if it causes you to trade rashly,  your returns may suffer. For most investors, investment returns are a much bigger deal than trading costs. Therefore, being able to trade for free can be counter-productive if it tempts you to become a day trader and tank your investment performance.

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