Saving on stock sales may be costly

Steady: Be content with matching the market, not beating it. Most novice investors would be better off with a sound mutual fund than trying to become an instant billionaire.

Dollar & Sense

October 03, 1999|By Robert Little | Robert Little,SUN STAFF

There exists for investors a guaranteed, sure-fire way to save money. Scrap your father's old broker for that discount broker on TV and you can knock maybe $100 off the cost of each stock transaction. Or plug into the Internet and pay $10 or less for each trade.

But before you reach for the phone, or the mouse, you might want to consider Professor Terrance Odean's advice for people who look inside their checkbooks to decide how to trade stock:

They probably ought to peer inside their psyches first.

Inexpensive stock trading does things to people, Odean found after studying the trading habits of thousands of investors through the mid-1990s. It makes them more reckless. And it often costs them money.

"One thing is fairly clear: If you go online with the cheaper commissions, and you do exactly the same trades you would have done otherwise, there's an unambiguous gain," said Odean, an assistant finance professor at the University of California at Davis.

"But people tend to trade more actively and speculatively online. And their performance shows that."

Fees paid for investing can be a noticeable component of overall performance, particularly for the everyday investor who can still count his or her zeros on one hand.

Some fees are easy to understand -- the amount your broker charges for each transaction, for instance.

Others are more obscure. While all mutual funds charge management fees, for instance, some might also charge a fee, or "load," when the investment is made -- maybe as high as 8.5 percent. Even a "no-load" fund might still charge for annual marketing expenses, called a 12(b)1 fee.

"There are so many options, it can be very confusing for investors," said Mitchell Peremel, vice president of Peremel & Co., a brokerage in Pikesville.

"The fees can add up, and they don't really have anything to do with your performance."

Investors can keep expenses down. They can shop for mutual funds whose upfront fees and maintenance charges don't wipe out market gains, or look for index funds or other products that charge very little. The mutual fund calculator at www.sec.gov can help determine the short-term and long-term costs of funds.

And investors can seek out brokers that charge smaller commissions. Discount brokers might charge $100 less for a stock transaction than a full-service broker. Online brokers barely charge a commission at all. Paying smaller fees could mean getting less personal service, but it might not. All brokers are different.

But while saving money on fees looks good on your personal balance sheet, the psychology behind your efforts to save a buck might make you a likely candidate to lose a lot more, Odean has found.

He tracked the investments of 78,000 households through a discount brokerage from 1991 to 1996. Among them were 1,600 investors who switched from telephone trading to Internet trading.

The Internet traders typically bought riskier stocks and had profits below the market average by as much as 3 percentage points -- even though they outperformed the market before they switched. And while they saved money on each trade, they tended to trade so often that the savings didn't matter.

Odean blamed the performance change largely on overconfidence. Investors were most likely to switch to Internet trading after a period of success trading with a broker by phone. And because people often attribute success to their own behavior and failure to the behavior of others, investors are quick to assume they don't need anyone's advice to make money, he said.

People who trade online also tend to compile vast amounts of data and conduct exhaustive research, Odean said. And they like to think that all their work was worthwhile, even if they don't really know what they're doing.

"You can know everything there is to know about a roulette wheel," said Odean. "You can know how it was made, what it's made of, the history of where the ball has landed. But you can never know where the ball is going to land next.

"The stock market is not as difficult to predict as a roulette wheel, but it's not a whole lot easier."

Odean's advice: Learn to be content with matching the market, not just with beating it. That means buying and holding, and investing in stable, low-cost mutual funds.

"I know, that's boring. I admit it," he said. "But you'll probably be happier with your return. If you really like trading stocks, that's fine. Just hold a little bit out and put it in stocks, then go ahead and have a riot."

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