A hyperactive stock market is the pickpocket of enterprise. – Warren Buffett, who became a billionaire through stock market investing
What are the two things in this world that we all cannot escape from?
- Death
- Tax
Everyone will eventually die; we just don’t know when. And whether we like it or not, every time we spend or save, we pay tax.
Many people in the stock market don’t realize how high the cost is when trading stocks in a daily or weekly basis. There are two inevitable expenses in this arena: tax and broker’s commission.
The Gotrocks family
In Warren’s 2005 annual letter to Berkshire Hathaway shareholders, he mentions an analogy how brokers pickpocket the profits supposed to be pocketed by investors.
Long ago, corporate America was owned by the Gotrocks family. After paying taxes for the dividends they receive, everyone’s wealth continues to grow at the same pace.
But Helpers came and urged each family member to outsmart one another through a scheme. The Helpers told them to buy the shares of one member and sell them to another. They were convinced.
And so the buying and selling of shares began.
Corporate America is still owned by the Gotrocks but the Helpers now play a role. They would facilitate the family’s transactions for a fee (commission), thus taking a portion of the total profits.
Unknown to family members, this scheme diminishes the family’s wealth.
The more each family member trades, the less each actually receives from the total profits. And the smaller slice of the pie each one has, the larger the slice the Helpers take.
And that’s where we are today, says Warren. Had investors ignored the Helpers and just stayed in their rocking chairs, they would have more money.
The supposedly 100 % profit that investors could take is now reduced to just 80 %. The 20 %? It goes to the pockets of brokers for facilitating the constant transactions between investors.
The worse is, that 80 % does not go to every investor in the market. It goes to the hand of intelligent investors.
‘Discount’ brokers
Many brokers pride and promote themselves as discount brokers; and most of them, if not all, are online brokers.
Meaning, they charge lesser fees compared to traditional brokers whom you need to contact through phone to execute your transaction.
Most of these brokers charge less than 1 % of the gross amount that you would buy or sell. Is it worth then to trade (buy and sell every now and then) since the charges are that small?
In my opinion, if you can perfectly time the market, it is the ideal way to put money in the stock market.
If you know when the market will go up and down, then the stock market would be like your ATM. It can dispense money wherever and whenever you like.
But can anyone perfectly time the market? No. Nobody can ever do so.
In fact, trying to beat the market through its short-term movements would only drive up your transaction costs.
So, no matter how discounted are the transactions fees your broker offers you, the said fees become higher once you total all your transactions.
Here’s the truth, as one writer says, some of your trades might make money, most of your trades will lose money, but your trader will always make money.
Heads, your broker wins; tails, your broker still wins.
Millions have tried, the evidence is clear: the more you trade, the less you keep. In an environment where activity is encouraged, transaction costs will continue to rise.
It would be better for you to just sit back and relax (that’s assuming you bought a wonderful business at a discounted price). You will do fine in the long run. The less you trade, the more you keep.
Minimizing your cost maximizes your profit.
It would be better for you to just play with your kids than play with stocks.
