What kind of investor are you? Do you invest in mutual funds and forget about them, or do you check in on your investments on a daily basis? While buy and hold certainly came under fire as the economy clawed its way out of recession, new research suggests that frequent trading within your portfolio won’t pay off.
In “Optimal Inattention to the Stock Market with Information Costs and Transactions Costs, Wharton finance Professor Andrew B. Abel and two colleagues Janice C. Eberly, finance Professor at the Kellogg School of Management at Northwestern University, and Stavros Panageas, finance Professor at the Booth School of Business at the University of Chicago, consider a range of factors from the value of the investor’s time to trading costs to determine the optimal amount times you should trade your portfolio, and how often to rebalance back to your initial targeted mix of stocks, bonds and cash.
Not surprisingly, the researchers found that if the time and monetary costs of adjusting a portfolio are very large, it pays to wait to make portfolio adjustments until market conditions make change worthwhile. Yet, they also found that even when costs are small, it makes more sense to make portfolio changes according to a schedule with surprisingly long intervals.
Professor Abel points out that many of the market’s ups and downs are random motion, noting that if investors make adjustments for every price change, they would be spending money trading just to reverse their prior trades. The lesson from his research, Abel says, is that “even if costs are small or modest, very frequent adjustment is unwarranted.”
He notes, “Even with commissions as low as $5 a trade — a level provided by some deep-discount brokerages — it would probably not pay to adjust a portfolio more often than every month or two.”
Yet another argument against day trading and for the frequent rebalancing of a well diversified portfolio.