Friday, March 25, 2016

Foolish Day Trader

Once upon a time, all of us were opening up our first investment accounts with dreams of making it big. No amount of money seemed to be insurmountable. This was even more so for the folks who had been lured into investing by stories of millionaire day traders. The idea seemed to be so attractive. Invest a little bit of money, multiply that by the amount it goes up every day or short it while it goes down, pull out your money and bam, you’re a millionaire!

Unfortunately, this was not the case for almost everyone who decided to continue to go down the road of day trading. In fact, studies consistently show that a very small minority (some claim less than 1%) are actually successful over the long term. This is due to a multitude of factors that drive the market every day and even more so due to the way the human brain functions. First off, there are big risks around every corner, especially if you’re in the business of shorting. If the profits are big, you usually bet bigger, and therefore can lose that much more on your next bet. Secondly, even when you do win, taxes and commission charges are always knocking on your door to pay up. Because the day trader is taxed at a higher rate because they trade on short term investments, they constantly get hit much harder than those of us who hold our stocks long.

In fact, for those of us who are long dividend growth investors, we can achieve a 0% tax rate on capital gains if we hold something longer than a year (long) if we’re taking it out in years that we have not hit the higher tax brackets for income. If the same person were to pull out quickly rather than holding it long, they would pay no less than 10% on their short term investment. Couple this with the fact that they pay commissions regardless of whether they make a profit or not and you’ve got a recipe for disaster. Even if you gain a huge discounted price for commission fees, you still see a few dollars come out each time. This quickly adds up when you talk about how many times a day trader must trade per year.

I remind myself of this by writing this article because I want to further drive home why we all do what we do as dividend investors. We do what we do to avoid the rat race that is day trading. We do so because we want to avoid the more risky and self-destructive habits that can so easily topple those that wish to look for short gains. When you buy a stock and hold it long, you avoid the mindset of the foolish day trader. After all, day trading is not a game of “if” you’re going to lose it. It’s a game of “when”. This is what we always have to remind ourselves when we look at the percentages that we are rewarded over the long term as dividend investors. Our money may not seem to jump as fast as day traders boast when they have good days but in the end, the tortoise beats the hare.

No comments:

Post a Comment