Costs are certain, so what happens when you remove the costs?

Exactly what you would expect to happen. When investors don’t have to pay for transactions, their performance increases significantly, even though their investment behaviour doesn’t change.

One of the most famous studies about retail investors is the seminal “Trading is hazardous to your wealth” by Brad Barber and Terrence Odean. It showed that back in the 1990s, retail investors who traded more had worse performance after costs because the additional performance they generated from additional trades was more than eaten up by fast-rising trading costs. This was so extreme that after costs, the investors who traded the most had negative performance after costs. This is why day-trading doesn’t work for retail investors. The costs are just too large to make money after fees.

But transaction costs for retail investors have declined massively since the late 1990s and one has to wonder if lower transaction costs have made it possible for retail day-traders to make money after fees. Well, Omri Even-Tov and his colleagues analysed trading data from eToro a low-cost retail brokerage firm. The chart below shows the performance of modern-day retail traders before and after fees depending on their portfolio turnover.

Trading still is hazardous to your wealth

Source: Even-Tov et al. (2023)

As you can see, investors who trade more frequently still tend to generate higher returns before transaction costs, but once these costs are taken off, the net of fees returns decline and even become negative for the most active traders. The math of trading costs still holds even though trading costs have declined significantly.

As an experiment, eToro removed all transaction costs for a four-week period in April and May 2019 in select countries as long as investors used no leverage (i.e. contracts for difference etc. were exempt from this fee waiver). This allowed the researchers to examine how trading behaviour and returns for investors changed when there are no more transaction costs.

And lo and behold, while trading behaviour did not change materially, the performance net of fees of retail investors improved significantly. In fact, it improved by pretty much exactly the amount they would otherwise have spent on transaction fees. This brings us back to the old adage that while performance is uncertain, fees are certain. And the simplest way to improve your performance is to reduce your fees.