21st Century Economics

The reason is believed to be overconfidence in a bull market that is encouraging investors to chase the latest shining star. Even when they miss, the bull market imposes a small penalty but that small penalty is adding up. Net returns are lower than if the investor had just stayed with some basic index fund for the duration and not traded so actively.

There is another source of loss that is a direct result of this increased trading. Each time a trade is made, a taxable event occurs. If you gained, it is taxed and if you loss, you are pressured to create an gain so you can take the loss.

For instance: If you sell at a $10,000 loss in the first quarter of the year, you cannot claim that loss (except under special circumstances) unless you have a gain of that amount some time during the year. If your normal dividends do not amount to $10,000, then you have to sell something to create a gain so you can deduct the loss. Now you have another taxable event.

Or you are just creating extra taxes because of the frequent trades you make in day trading or chasing the numbers. The end result is that you are paying taxes on each transaction that lowers your overall gain.

One other way that you might be gaining in these taxable events is by investing in a mutual fund that has an active manager that believes in a high turnover rate. This creates capital gains that may be distributed to the investors.

An alternative is to invest in a few index funds that do little trading. You could also trade in tax exempt bonds and other investments and move your money into a tax-exempt money fund between trades. If it is in a bank, it continues to earn taxable income.

Finally, whatever you do, try to hold your investments that show a profit for at least one year so you can take advantage of the 20% long-term capital gains tax rate. If you don’t the capital gains can be so high as to offset your profits on the trade.