Linus Wilson's  Instablog

Linus Wilson
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Dr. Linus Wilson is an associate professor of finance at the University of Louisiana at Lafayette. He received his doctor of philosophy in financial economics from the University of Oxford in England in 2007. He has conducted extensive research into the Troubled Asset Relief Program (TARP). He... More
My company:
Oxriver Capital
My blog:
Academic Research
  • To Trade Or Not To Trade, That Is The Question 0 comments
    Mar 8, 2014 9:18 AM | about stocks: SPY, VOO, IVV

    I got slapped with a $75 fee from Scottrade after I rolled over a IRA with that broker to Vanguard. I was more concerned about the free ETF trades for Vanguard ETF's and nobody at Scottrade, which loves to tout their "low cost" $7 trades, bothered to mention the $75 exit fee when they were begging me to keep my tiny IRA with their brokerage. Fees and brokerage commissions from places like (SCWB), (NASDAQ:ETFC), and (NASDAQ:IBKR), in other words, are the bane of any active investor. For passive investors, who have more enjoyable things to do than log into their various retirement account providers' sites, the cost of their dwindling leisure time is a big impediment to rebalancing their portfolio.

    In my most recent paper, I attempt to develop a simple model that can be easily inputted into an Excel spreadsheet to tell an investor if the next $7 trade or lost hour of leisure time is worth the desired portfolio adjustment. One academic study showed that brokerage customers typically eat up several percent per year in returns because of excessive trading and brokerage commissions. It found that on average men lost 2.7 percent of their returns to excessive trading and women lost 1.7 percent of their returns to over trading.

    A few things are clear from the study. The more your target portfolio weights are distant from your actual portfolio weights, the greater the benefits from rebalancing. In addition, it makes sense to do more trades in larger accounts or when brokerage fees are lower. Thus, a person with a $400,000 balance in a 401(k) should rebalance more often than one with a $100,000 account balance. If you want to increase your holdings of a risky asset, you should hesitate if your forecast of its returns is very noisy or you are very risk averse. Finally, a higher (lower) return to the risky asset should make you more likely to pay the trading costs to increase (decrease) your holdings of it if its expected return is higher (lower).

    I run a hedge fund Oxriver Capital which times U.S. equity markets, (NYSEARCA:SPY), (NYSEARCA:IVV), or (NYSEARCA:VOO), and brokerage commissions always give me pause when I think about the next trade. In investments to the main fund at Oxriver Capital or to separately managed accounts (SMA's) trades are only approved if the transaction cost model says they make sense. Investors judge the fund by its returns net of fees and commissions, thus a good transaction cost model correctly applied can often add more return than another alpha factor that helps the fund better predict the direction of the stock market. In other words not all "good" trade ideas are worth excecuting. Warren Buffett once compared his investing process to a batter who can be never struck out on called strikes. He only takes a swing when a really good trade comes along.

    Disclosure: I am long SPY, VOO.

    Stocks: SPY, VOO, IVV
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