We have discussed the many reasons on why we use the mutual fund company Dimensional Fund Advisors (DFA) for our clients and ourselves. (See this post for other reasons: Why DFA) One of the hidden advantages is how they trade their portfolios both for their stock portfolios and bond (fixed income) portfolios. They manage the portfolios with patience and this approach captures small incremental gains which result in a better investment performance for their various portfolios.
In this DFA video, they discuss how they buy and sell securities and how their approach allows for reduced transaction costs that all buyers and sellers pay as they transact with other participants. These costs are known as transaction costs. These costs are a drag on investment returns and generally unknown by investors.
Studies of individual and institutional investors in the U.S. and elsewhere have found that those who trade the least earn the most. One reason for this difference is the result of these transaction costs and also less taxes due. In addition, people have the tendency, when they trade more often, of getting caught up in what is hot at the moment and buying it just before it cools off and vice versa.
Brokerage houses run TV commercials highlighting the speed of their systems to handle individuals trading needs. This is counter to the best practices for most individuals. The ability to invest on a longer horizon than most people will be the key. Focusing on the long term goals will help individuals reduce the tendency to over trade their portfolio regardless of the speed of the transactions. This behavior modification is one of key benefits that we supply our clients.
In the video, they highlight what occurs when someone enters a car dealer to purchase a car. If the purchaser has specific requirements (color, specific options needed) as well as an urgency to buy, the dealer will charge a higher price to accommodate the buyer. If someone else is open to different potential options (color, add-ons) and can be flexible when the car is delivered, this purchaser is able to take advantage of a lower price.
Same goes for the buying and selling of securities: bonds and stocks. Click below to watch this 3 minute video.
The stock market serves as a relocation center at which money is moved from the active to the patient.