A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

EXHIBIT 
ONE 
THE 
TIMING
PENALTY: EQUITY FUND CASH
FLOW FOLLOWS THE STOCK
MARKET

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EXHIBIT TWO THE SELECTION
PENALTY: 
QUARTERLY 
FLOW
INTO 
GROWTH 
AND 
VALUE
FUNDS, 
AND 
THE 
NASDAQ’S
CLOSE
Source: Strategic Insight.

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2. Avoid Overtrading
Behavioral finance specialists have found that investors
tend to be overconfident in their judgments and invariably do
too much trading for their own financial well-being. Many
investors move from stock to stock or from mutual fund to
mutual fund as if they were selecting and discarding cards in a
game of gin rummy. Investors accomplish nothing from this
behavior except to incur transactions costs and to pay more
in taxes. Short-term gains are taxed at regular income tax rates.
The buy-and-hold investor defers any tax payments on the
gains and may avoid taxes completely if stocks are held until
distributed as part of one’s estate. Remember the advice of
the legendary investor Warren Buffett: Lethargy bordering on
sloth remains the best investment style. The correct holding
period for the stock market is forever.
The cost of overtrading is quite substantial. Using data on
the trading behavior of approximately 66,000 households
during the period 1991–96, Barber and Odean found that the
average household in the sample earned an annual return of
16.4 percent, while the market returned 17.9 percent. In
contrast, the annual return to the portfolio of households that
traded the most was only 11.4 percent. In other words, the

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portfolios of those households that traded the most
substantially underperformed more passive benchmarks. In
addition, men tended to be more overconfident and trade far
more frequently than women. Odean’s advice to investors: If
you are contemplating making a stock trade (and you are
married), ask your wife if you should do it.