Imagine the following: You, the investor, believe you have an uncanny skill at picking stocks. You set up an online trading account and begin to buy and sell.
As it turns out, you are quite good. You pour more money into your brokerage account and up your trading. After the first year, you look at your results: You have trounced the indexes. You snicker at your friends who invest passively in low-cost, low-turnover indexes. ...
Over 24 years, you tally up gains and losses. The markets are up, on average, about 9.3 percent annually. You, the World’s Greatest Trader, do much better — 40 percent better. That’s better than most of today’s hedge funds. It is certainly better than most average mom-and-pop investors.
How did you do vs. your friends the passive indexers?
About the same.
Wait, how on Earth is that possible? ... In a word, taxes. Traders pay a healthy tax of 30 percent or more on short-term capital gains. Effectively, you lose the benefits of compounding on one-third of those gains. Over time, this has a tremendous impact on your net returns. ...
The silly little secret of investing is, simpler is better. Drop your money into a Total U.S. Stock Market fund, a Total International fund, and a broad-based bond fund.
Then, don't move anything, don't sell your holdings, just let them percolate over long stretches of time.
Eighteen years ago, the wife and I put $9,000 into Vanguard's Total Stock Market fund for the six-year-old. Eighteen years later, after burst stock bubbles and a major recession, the 9 grand is up around $33,000, give or take. The secret is, we've never touched the money, and seldom even looked at the performance of the fund. (Which helps us to not touch the money.)
There is something to be said to 1) Low costs, and 2) Letting everything ride. Most investors' biggest hurdle is panic selling.