Could A “Transaction Tax” Be A Good Thing?

Such was the conclusion of Daniel Wiener, editor of The Independent Adviser.

“Free trading doesn’t help investors. It only encourages bad behavior. As someone who’s been managing client assets for more than 25 years, we talk about ‘time in the market, not market timing’ because long-term investing works.”

The annual Dalbar Investor Survey shows the same. Equity investors consistently do worse than the index.

transaction tax, #MacroView: Could A “Transaction Tax” Be A Good Thing?

Such is due primarily to the psychological pitfalls that occur from “herding” to “confirmation bias.” 

“When discussing investor behavior it is helpful to first understand the specific thoughts and actions that lead to poor decision-making. Investor behavior is not simply buying and selling at the wrong time, it is the psychological traps, triggers and misconceptions that cause investors to act irrationally. That irrationality leads to buying and selling at the wrong time, which leads to underperformance.” – Dalbar

Another study by Barber, Lee, Liu, and Odean shows much the same:

“On average, individual investors lose money from trading. Barber and Odean (2000) document that the majority of losses incurred can be traced to trading costs. However, trading costs are not the whole story. On average, individual investors have perverse security selection abilities. They buy stocks that earn subpar returns and sell stocks that earn strong returns (Odean (1999)). In aggregate, the losses of individuals are material” – Barber, Lee, Liu, and Odean

Shrinking Holding Periods

Repeated studies show that long-term holding periods lead to better outcomes. Short-term trading, driven by overconfidence, generally leads to worse.

“The length of time that investors hold shares has been shrinking for decades but the trend accelerated this year. There are different ways of slicing it. However, Reuters calculations of NYSE exchange data show the average holding period for U.S. shares was 5-1/2 months in June. This was a decline from 8-1/2 months at end-2019.

The previous record low of six months was hit just after the 2008 crisis. In 1999, for example, 14 months was the average.” – Reuters

transaction tax, #MacroView: Could A “Transaction Tax” Be A Good Thing?

Why are holdings times shrinking?

“From 0% interest rates, pandemic-induced volatility to sports gamblers that are bored to death at home due to lack of sports betting. Then there are the millennials living in their parents’ basements with nothing else to do. Also, the day-traders by the millions playing the market using the Robinhood app. And the unemployed trying to multiply their $600+ weekly unemployment checks and also have fun doing it. Don’t forget those same people also throwing the $1,200 stimulus checks into the market to make some money to pay bills, etc. Not to mention algorithm-based machine trading by big institutions, locked-down realtors unable to flip houses finding their luck in the stock market, etc.” – David Hunkar via TFS

While the reasons for the continuing decline in holding periods are many, commission-free trading is exacerbating that trend by removing the “brake pedal” from the speeding car.

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