Why Too Much Trading Can Cost You

With all of the effort you put into managing your investment account when you are getting started, it's worth reminding yourself why trading too much can eat into your returns:

1. Trading almost always caries some kind of cost. Depending on what you are trading and where you have your account, you may pay a transaction fee for selling one investment and another fee for buying the new investment in its place. These fees aren't huge, but they can add up over time.

2. You could be increasing your taxes. If you are in a tax-deferred account—a 401k, Roth or IRA, for instance—this won't be a problem for you. In those instances taxes get calculated only when you withdraw the money. But if you have a regular, non tax-deferred investment account, the profit goes on your tax bill every time you make a trade. Worse yet, if you have not owned that stock or fund for more than a year, you are going to pay the higher short-term capital gains tax. Of course, taxes are not a problem if you have lost money on your investment, but that's a different issue, isn't it?

3. Studies consistently show that frequent traders do worse. This is really a human psychology problem—there is no obvious reason beyond those I've just listed for why someone who frequently buys and sells should do worse in the market. But our human tendency to second-guess ourselves, listen to "experts" and rumors, and impulsively stray from our original plans means that frequent trading can easily cut into returns. To see more on this, check out Terrence Odean's Do Investors Trade Too Much, Odean's interview with the American Association of Individual Investors, or John Teall's book Financial Trading and Investing (Academic Press, 2013).