Who gets a higher return- a trader or an investor?

I was recently watching a Disney movie with my two young boys, who are going through a basketball phase. The film featured real-life basketball star Kevin Durant, who presently plays for Oklahoma City Thunder. Incidentally, he earns a nice income of around USD 17.83 million a year… Anyway, in the movie his work ethic catchphrase is: “Hard work beats talent when talent fails to work hard”.

Over the decades, sport has traditionally advocated the need to work very hard to succeed in a chosen skill. Particularly over the 80s and 90s, this mindset traversed into the business world; it was presumed that to prosper, you had to work long hours. Dedication, focus, perseverance and sacrifice were considered the cornerstones of success.

It seems natural, therefore, that when people consider investing, they assume the same parameters apply. Let me give you an example: There is a widespread belief that if you trade daily in the share market, you will achieve much higher returns than by simply having a buy-hold strategy. The basis of this logic might stem from the belief that working hard on our investments daily must—or should—equate to better results. If you’re watching the charts, executing many trades each day and are generally a very active investor, surely you must achieve better gains?

However, an article by Brad M. Barber and Terrance Odean published in The Journal of Finance, “Trading Is Hazardous to Your Wealth”found that the portfolios of investors who actively traded underperformed on the market by around 6.5%. So perhaps a more laid-back approach to investing actually produces a higher rate of return than that achieved by a hard working trader.

In my view, the discrepancy is due to a lack of understanding of two important functions when it comes to investment planning: The first is execution; the other is research, analysis and strategy.

People often believe execution is the most important aspect of trading; if you increase velocity, surely there is the potential to proportionately increase the return. This is considered the ‘action’ component of investing.

Charlie Munger (Warren Buffett’s right-hand man) recently chaired the 2016 Daily Journal Corporation Meeting. During the event, he was asked a series of questions, and one related to the importance of thinking. This was his response:

“There are two things Warren and I have done. One is that we spend a lot of time thinking. Our schedules are not that crowded, and we sit around and think constantly. In a way, we look more like academics than businessmen. My system has always been to sit quietly for a few hours. I don’t mind if there are long period where nothing happens. Warren’s the same way. He’s sitting on top of an empire now. Sometimes he clears his schedule for a haircut. His calendar will say ‘Tuesday: Haircut day’.”

Over the years, I have noticed this trait in a lot of top-performing asset managers. The majority of their day is spent reading, researching and thinking about the markets, sectors or investment options. There may be periods of action that involve buying or selling, but this tends to be a small percentage of their productive time.

It seems there is a gradual shift in the twenty-first century mindset; people are starting to realise the benefits of working smarter rather than harder. I think this subtle shift is a wise one. Long days of low productivity seem fruitless compared to shorter, more efficient periods of concentrated focus and energy with a more balanced lifestyle. I often find this approach to be far more productive in the long run—it also avoids burnout.

So the next time you are having dinner with a friend and they tell you they are trading in their spare time and working pretty hard at their stocks to “bring it all together”, you might respond: “Hey, you should check The Journal of Finance’s study on trading—it might give you an edge on your strategy.” 

Have you heard the joke about the pilot and the dog? The dog is there to bite the pilot if he so much as tries to touch the controls; this leaves the pilot with one job: to feed the dog. To some degree, this also applies to investing.

As an investor, think long and hard before you decide to push that buy or sell button; you don’t want to experience a bite from the dog, so perhaps you should just keep feeding it.

Please also remember that before embarking on any investment decision, you should always seek professional guidance from a licensed financial planner. Of course, I recommend AJ Financial Planning