Back in the wild and woolly and, well, more innocent days of the tech stock boom — you remember it, don’t you? — it seemed like everyone and his brother and second cousin twice removed had taken up day-trading. To a lot of impatient investors, it seemed like a no-brainer — at least, until the stocks that had been going up, up, up started going down, down, down, and a lot of day traders found out the hard way that what they thought was their own personal genius was actually just an overheated bull market.
Now, in these more chastened times, we’re beginning to hear stories about investors turning to day-trading not out of greed but fear.
With stocks lurching upward and downward with every new headline out of Europe, some people have convinced themselves that an old-fashioned buy-and-hold strategy is too risky for our uncertain times and that day-trading their 401(k)s is a safer way to prepare for retirement.
A somewhat alarming piece in the Los Angeles Times recently looked at what seems to be the growing appeal of day-trading for current and hopeful retirees. According to Richard Schmitt, an adjunct professor of retirement planning at Golden Gate University in San Francisco, who’s written a book on the subject, day-trading can dramatically boost your returns. “I’ve seen so many people make their 401(k)s into 201(k)s,” Schmitt told the Times. “This gives you the opportunity to make it into an 801(k).”
Of course, buying a lottery ticket gives you the opportunity to become a millionaire. But that doesn’t mean buying handfuls of lottery tickets is a prudent way to prepare for retirement.
Nonetheless, some have been convinced. “I didn’t see a lot of returns using the buy-and-hold method,” one software engineer who hopes to retire early told the Times. Worried about the prospect of losing his shirt if the stock market took another big plunge, he started trading his retirement accounts. “I don’t see how it can be dangerous,” he explained.
Famous last words. Unfortunately, day-trading is bad news for almost everyone, whether it’s motivated by greed or fear.
The fact is, most individual investors who turn to day-trading lose money, sometimes a lot. One 2003 study (PDF) by finance professors Douglas J. Jordan and J. David Diltz found that money-losing day traders outnumber successful day traders by 2 to 1; after accounting for trading fees and other costs, only about 20% of day traders are marginally profitable. Another famous study (PDF) on day-trading, based on extensive data from the Taiwan stock market, found that more than 80% of day traders lost money.
Maybe you’re one of the lucky ones who can make money day-trading, but I wouldn’t bet on it.
Day traders sometimes argue that their methods are safer than buy and hold because they take all their money off the table at the end of the day, thus ensuring that they won’t lose money if something horrible happens when U.S. markets are closed. Trouble is, this also guarantees that they will miss out on the gains if something good happens overnight. While day-to-day stock moves are virtually impossible to predict, over the long run, stocks have a tendency to go up. If you’re planning for retirement, being out of the market is a greater risk than being in it, making it far more likely you’ll reach retirement age with a seriously underdeveloped nest egg.
Luckily, as is the case with a lot of so-called trends you find in media stories, there’s little evidence that day-trading 401(k)s is an actual thing in the world. As the Times itself points out, only about 15% of people with 401(k)s made any changes to them last year, according to a study by benefits firm Aon Hewitt. As Reuters finance blogger Felix Salmon observes, 401(k)s aren’t built for trading:
[Most] 401(k) plans deliberately make it very difficult to do this kind of thing. … And if this kind of activity catches on, chances are the fund administrators will put an end to even the existing loopholes. These accounts are designed for buy-and-hold retirement funds, not for trading.
Indeed, the only one guaranteed to make money from this alleged trend is the aforementioned Schmitt, whose book, 401(k) Day Trading: The Art of Cashing In on a Shaky Market in Minutes a Day, retails for a fat $49.95.