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6 REASONS WHY DAY-TRADING YOUR 401K IS A RECIPE FOR DISASTER
BY Ken Sweet, Contributor
Apparently it's now kosher to day-trade your retirement account, at least that is what The Los Angeles Times told investors on Monday.
I didn't know what to make of the story when I first read it other than I wanted to hit my head repeatedly against a wall. I worry about articles like that Times piece, because it presents a side to investing that few (if any) should try. Somewhere, some regular retail investor is going to read that article and think "Hey, this might be a good idea."
So I'm here to say, in fact, no one should be day trading his or her retirement account. No one.
Not convinced? Here's a few reason why you shouldn't:
1) It's you versus Wall Street. You're not going to win.
Over the past 30 years, Wall Street firms have hired some of the brightest minds in the investing economists, mathematical geniuses, strategists to help them beat their competitors by the slightest of margins. The difference between a 9% return and a 10% return on investment is massively lucrative when we're talking bank portfolios in the hundreds of millions to billions of dollars.
These 20- and 30-somethings are armed with Bloomberg Terminals, in-house proprietary research, direct access to business leaders and politicians and billions of dollars in leverage to help them outperform the market. They also have near-instant access to capital markets and dark pools of liquidity.
"These investment firms have armies of people who focus their entire lives on one segment of the market, and you're a guy who's watching the market using a Charles Schwab trading screen," said Dan Morgan, a portfolio manager with Synovus Trust Securities.
It's not a zero-sum game. You could benefit from stocks going up just like Morgan Stanley would. But in times when there is increased volatility, actively-managed mutual funds and banks can employ strategies that can help lower their exposure and risk to the market. You cannot, outside of purchasing certain extremely specialized ETFs, which leaves you more exposed to violent swings in the market, Morgan said.
2) Guessing short-term price direction isn't a strategy
More importantly, most day traders these days aren't guessing price movement, which is the typical strategy for the average retail investor.
Typical day-traders these days are using arbitrage strategies comparing prices on similar investments and trying to make money on the difference, or spread, between those investments. Arbitrage is a valid strategy, but it often requires computers and high-frequency trading algorithms to succeed at it. You sitting at home at your Charles Schwab trading screen (no offense to Schwab, they're good people) isn't going to beat the Goldman Sachs kid who is using arbitrage on General Electric shares 5,000 times a day.
3) You're giving up a huge chunk of your potential return by day-trading your retirement
The stock market isn't all up-and-down price movement. A good portion of your potential return that's hard to overlook is compounded dividends blue chip companies like Coca-Cola, Walt Disney, General Electric that pay quarterly dividends on a stockholder's investment.
By day-trading your account, you're cutting yourself off from 40% your potential return because you're not in the stock long enough to collect those important quarterly dividends, said Marty LeClerc, portfolio manager with Barrack Yard Advisors.
This means you need to make up for those losses somewhere else, most likely by attempting to outperform the market using price direction.
"And predicting daily stock price movements is known by another name: gambling," LeClerc said. "You might as well head to the poker table with your retirement."
4) You cannot (easily) short a retirement account
One reason why many people day trade is because they're trying (successfully or unsuccessfully) to guess price movement. Well, stocks to go down, and the only way to benefit from a falling stock market is to sell stocks short the process where you borrow shares from another party in order to bet that a stock's price will go down.
While shorting is valid and, I believe, is a healthy phenomenon in the market, the IRS does not allow shorting in a self-directed IRA for tax reasons. You almost always need a margin account to short stocks, and the IRS treats margin accounts as an unqualified distribution meaning you're going to pay penalties and tax on your IRA if you decide to short.
There are ways to short the market through the use of inverse exchange-traded funds, which you're technically "long" the "short position" in the the market. For example ProShares has an UltraShort S&P 500 ETF. But like any ultra-short ETF, you would need to be in-and-out of quickly.
5) This isn't a market to be day-trading in (if there ever is one)
Greece is saved! Greece is doomed! The United States is saved! The United States is doomed!
Wall Street has been in a bear market since the United States' credit rating was downgraded in August of last year (on top of the ongoing euro crisis). It's nothing like the bear market of 2008-2009, but it's certainly not something an average investor should be trying to put daily bets into.
If stocks were in a secular bull market, where stocks were moving consistently higher on average, then day-trading may be worth exploring, Morgan said. But even then, you're still competing against the performance of Wall Street.
"Everyone I've met who has gotten into day trading may have had some success in the beginning when it's a bull market, but I don't know anyone who has had success over the long term," he said.
6) Active management of a retirement account is relatively cheap
If you really want a human element involved in your retirement planning, consider getting an actively-managed portfolio set up with a local wealth adviser.
Actively-managed portfolios are not just for the wealthy. Typically a portfolio manager will take between 1-2% of your portfolio's return as his or her fee for running your account. But in exchange, you get a human involved with your retirement who can make informed decisions about whether to buy or sell stocks on your behalf when market conditions are right.
Active management isn't for everyone. There are arguments that a human element involved in the market isn't going to consistently outperform the market over the long-term and it's best just to be invested passively through index funds or other similar types of investments. But for a couple thousand dollars a year on a $100,000 portfolio, maybe it's worth the piece of mind.
Day-trading is a legitimate form of investing, but it's something that is done with money that you're willing to burn because most likely you're going to make mistakes. I know people who spend years using day trading practice accounts before they jumped into it with real money.
Your retirement is not play money. It's your retirement. Treat it with the respect it deserves, and invest it appropriately.
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