How serious are the consequences of frequent trading?

The first principle of compound interest is: Never interrupt this process unless absolutely necessary. --Charlie Munger
Friends often ask: My fund has some paper gains, should I sell to lock in profits? The current situation is unclear, or some blogger says the stock market will have a major correction in the short term. Should I sell my funds and buy them back after a big drop? In fact, whenever I encounter such questions, I always say: Stay committed to regular investing, hold long-term, and avoid unnecessary moves!
I believe that once we start buying and selling based on market conditions, we easily fall into the trap of frequent trading. And I am firmly against frequent trading.
The most important reason is: Most investors often buy and sell funds at the wrong time, such as buying high and selling low, resulting in investment returns far below the inherent returns of the index.
Another important reason is the cost of trading itself. Today, I will analyze this.
1. The cost of frequent trading in A-shares
As we all know, when trading stocks and ETF funds in A-shares, we have to pay transaction fees. These mainly include stamp duty, transfer fees, regulatory fees, and commissions. The specific fee standards are as follows:
1. Stamp duty is 0.05% of the transaction amount, charged only to the seller.
2. Transfer fees are charged to both buyers and sellers, at 0.001% of the transaction amount.
3. Regulatory fees: Include securities management fees and handling fees. The securities management fee is 0.00487%, and the handling fee is 0.002%, totaling 0.00687%.
4. Brokerage commissions: Usually range from 0.3% to 0.03%, with a minimum of 5 yuan. So, if I only buy 1,000 yuan worth of ETF, I still have to pay a 5 yuan commission, equivalent to 0.5% of the capital!
In total:
--Maximum total purchase cost: 0.31%, minimum: 0.04%
--Maximum total selling cost: 0.36%, minimum: 0.09%
--Total cost per round-trip trade: Maximum 0.67%, minimum 0.13%, average 0.4%
For example, if I buy 10,000 yuan worth of S&P 500 ETF 51300, the highest fee would be 31 yuan, and the lowest would be 4 yuan. If I sell them at the same price a month later, the highest cost would be 36 yuan, and the lowest would be 9 yuan. So, for one round-trip trade, my loss would range from 13 yuan to 67 yuan.
If I trade 10 times a year, transaction fees alone could lead to a maximum loss of 6.7%. Assuming the fund's inherent return is 10%, after deducting transaction fees, my expected return would only be 3.3%.
Even at the lowest commission rate, the cost per round-trip trade is 0.13%. Trading 10 times a year would still incur fees of 1.3%.
If I invest in off-exchange funds, although I avoid these stock trading fees, I still have to pay subscription and redemption fees.
Taking the Bosera S&P 500 ETF Link A Fund 050025 as an example, the maximum subscription fee is 1.2%, and the maximum redemption fee is 1.5%, totaling 2.7%. If I trade 10 times a year, the fees would be as high as 27%!
This cost is far higher than that of on-exchange ETFs. Therefore, I recommend investing in on-exchange ETFs rather than off-exchange funds.
From this, it is clear that the cost of investing in index funds in A-shares cannot be ignored.
Suppose I invest a sum of money this year in on-exchange ETF 513500 and hold it until I retire 30 years later and need the money. The transaction cost for this investment would be the cost of one round-trip trade, ranging from 0.13% to 0.67%, averaging 0.4%. Assuming the fund's inherent annualized return is 10.8% and the management fee is 0.8%, my actual annual return would be 10%. After 30 years, my total return would be:
(1 + 10%)^30 - 1 = 1645%
Even deducting the highest transaction cost of 0.69%, my return would still be 1644%. The transaction cost is almost negligible.
However, if I trade 10 times a year with an average transaction cost of 0.4%, my actual annualized return would be:
10% - 0.4% × 10 = 6%
After 30 years, my total return would be:
(1 + 6%)^30 - 1 = 474%
Since 474% / 1645% = 29%, we can say that frequent trading yields only 29% of long-term holding returns. In other words, transaction fees eat up 71% of my profits!
If we extend the time window to 40 years, the gap will be even larger, and transaction fees will eat up about 80% of the profits!
2. The consequences of frequent trading in the U.S. stock market
In the U.S., trading ETFs and traditional funds does not incur stamp duty or brokerage commissions. However, when trading ETFs, we still face bid-ask spreads, which are considered a transaction cost for investors.
For example, the bid-ask spread for S&P 500 ETF VOO is 0.01%, SPY's is around 0.02%, and VGT's average spread is as high as 0.04%.
Of course, trading traditional index funds like VFIAX does not have bid-ask spread issues.
Besides spreads, capital gains tax is a bigger cost when trading ETFs and traditional index funds in taxable accounts.
If we hold a fund for less than a year, capital gains are taxed as ordinary income. For high-income households, combined federal and state taxes can exceed 40%.
If the fund's inherent annualized return is 11%, with 2% dividends and 9% price growth, and we frequently trade within a year, even ignoring bid-ask spreads, our pre-tax return would still be 11%, but we would have to pay taxes on the 9% short-term capital gains.
Assuming a marginal tax rate of 40% and a 20% dividend tax, our actual return would be:
2% × (1 - 20%) + 9% × (1 - 40%) = 7%
After 30 years, our total return would be:
(1 + 7%)^30 - 1 = 661%
If we hold long-term, our annual return would be:
2% × (1 - 20%) + 9% = 10.8%
After 30 years, our nominal return would be:
(1 + 10.8%)^30 - 1 = 2069%
Even if we sell all the funds then and pay the highest long-term capital gains tax of 20%, our after-tax return would still be:
2069% × (1 - 20%) = 1655%
And 661% / 1655% = 40%.
We can see that frequent trading yields only 40% of long-term holding returns. In other words, taxes eat up 60% of the profits!
If we extend the time window to 40 years, the gap will widen further, and taxes will eat up about 70% of the profits!
Note: If these trades occur in tax-advantaged accounts like IRAs, the tax impact disappears. However, we still incur costs like bid-ask spreads, though the consequences are less severe.
3. Summary
From the above analysis, we can see that whether in China or the U.S., the transaction costs of frequent trading are extremely high. They severely erode investment returns and significantly hinder our path to financial freedom.
In fact, similar conclusions hold in other countries. Interested friends can analyze their own country's situation.
For this reason, I advise everyone not to trade frequently but to adhere to a long-term holding strategy. This minimizes transaction costs and maximizes the inherent returns of the fund.$NVIDIA(NVDA.US) $Tesla(TSLA.US) $AMD(AMD.US) $Netflix(NFLX.US) $Super Micro Computer(SMCI.US) $Robinhood(HOOD.US) $Coinbase(COIN.US) $SPDR S&P 500(SPY.US) $VG S&P 500(VOO.US)