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How much should retirees actively trade their portfolios?
The reason I’m asking this age-old question now is that, if trading ever were a good idea, it should show up in 2020’s performance. A trader who got out of equities at the February high and back in at the March low would now be sitting on a year-to-date gain of over 70%. That compares to a gain of “just” 14% for buying and holding.
It’s of course unrealistic to expect that anyone could get out of the market at the exact high and then back in again at the exact low. Nevertheless, there is a lot of room between 14% and 70% for traders to demonstrate their worth to retirees and soon-to-be retirees.
Of course, this year also presented plenty of opportunities to stumble. A trader who waited until the March low to shift form equities to cash, and who has been out of the market ever since, would be sitting in a greater-than-30% loss position in early December. This was a point made earlier this week by the Wells Fargo Investment Institute.
To find out how traders actually navigated 2020’s high-risk/high-opportunity environment, I analyzed the numerous investment newsletter portfolios whose track records my firm audits. I wanted to see if these real-world portfolios were ahead or behind where they would have been had they undertaken no trades since the beginning of the year.
To do that, I created a hypothetical portfolio for each of these actual portfolios that was an exact copy as of the beginning of this year—and which made no subsequent changes. If this hypothetical “frozen” portfolio is today worth just as much or more than its corresponding real-world portfolio, then we know its trading didn’t add value.
That turned out to be the case in slightly more than half of the portfolios my firm monitors—52%, to be exact. What conclusion can we draw from this? On the one hand, this percentage is lower than in other years in which I conducted a similar test on investment newsletters. So to that extent, traders can take some solace that in a year like 2020 there are somewhat increased odds of success.
On the other hand, this percentage is still above 50%. That means the odds are still against your being able to add value from your trading.
Taxes
An additional result is relevant to those of you who trade equities in a taxable portfolio. Above and beyond the 52% mentioned above, an additional 17% of the portfolios are ahead of their frozen analogues by less than 5 percentage points. That’s worth mentioning because my firm’s performance calculations do not take taxes into account.
So on an after-tax basis, it’s very likely that these additional 17% would be behind where they would have been had they stuck with what they were recommending at the beginning of the year. That would mean that just 31% of the portfolios added value on an after-tax basis through their trading.
It’s also worth remembering that the investment newsletters on whose portfolios I conducted this test have stellar long-term records. That’s not an accident. In 2016, when my performance-tracking firm adopted a new business model in which newsletters paid a flat fee to have their track records audited, only those services with the best long-term returns were interested in participating.
I think it’s telling that, even among the advisers with the very best long-term records, the odds are against them when they try to add value through short-term trading. And this is true even in a year like 2020 in which there is such opportunity for such trading to add value.
The psychological dimension of trading
These results do not necessarily mean you should never trade. Many retirees are engaged and excited by the challenge of beating the market, and it’s not psychologically realistic or even healthy to tell them to give that up.
It’s possible to both recognize this psychological reality and take into account the odds against you when trying to beat an index fund. The solution was proposed decades ago by the late Harry Browne, editor of a newsletter called “Harry Browne’s Special Reports”: Divide your investible assets into two portfolios—one Permanent and Speculative. The former, which would contain the bulk of your assets, would be invested in index funds and held for the long term with little or no change.
The second portfolio would contain your play money in which you try your hardest to beat the market.
Notice that, by placing the bulk of your assets in the Permanent Portfolio, you’re not risking your retirement financial security through your trading. Notice also that this dual-portfolio structure provides you with a continuing real-world test of your trading ability. While there will be times when your Speculative portfolio will outperform your Permanent one, it’s a good bet that over periods of at least several years the latter will come out ahead.
Still, provided you structure your finances correctly, there’s no harm in trying. Good luck!
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.
