10th July 2012: Day Trading 401(k)s

Software engineer Vlad Tokarev decided to day trade his retirement account. An LA Times profile documents the mistakes of Tokarev and other investors:

 

Minutes before the market closes every day, Tokarev buys or sells a mutual fund linked to the Standard & Poor’s 500 stock index. His goal is to profit from temporary fluctuations in stock prices, so he buys when stocks are falling and sells when they’re rising.

 

Wrong timing I: US stockmarkets tend to rally in the first hour of trade and the last half hour. Wrong timing II: buying at the end of day exposes the trader to overnight risk and possible market gaps. Wrong instrument I: a low-cost basket of exchange traded funds would be better than a mutual fund. Wrong instrument II: the S&P 500 is volatile and its index composition does not necessarily represent the market or sectors that perform well in current market conditions. Wrong asset allocation and decision biases: Tokarev is 49; wants to retire before 65; so his choice of day trading (availability bias) reflects an attempt to make-up for recent stockmarket losses (recency bias). Wrong risk management I: Tokarev day trades a third of his retirement fund whereas most traders recommend a position sizing of 1-2% of your portfolio on a specific trade. Wrong risk management II: Tokarev tells the LA Times, “”That’s what people usually say about day trading — but I don’t see how it can be dangerous.” This comment illustrates the irrational escalation bias, belief bias, blindspot bias, and the focusing effect. Tokarev also may not have factored in the  trading and execution costs, and capital gains tax implications of his day-trading. Instead, as Reuters’ Felix Salmon discovered, Tokarev appears to have based his trading strategy on a Wiley Finance book (Richard Schmitt‘s 4o1(k) Day Trading which has a bare-bones author-created website).

 

The LA Times article also quotes Wells Fargo customer complaints officer Joe Hansman:

 

Joe Hansman, 29, who handles customer complaints at Wells Fargo, shifts money among two conservative mutual funds in his 401(k) and the banking company’s own stock. He trades 10 to 15 times a month, steering money into Wells Fargo’s stock when he expects it to rally for a few day.

“When I told my wife about it she was really nervous … until I educated her on what it all entails and how poorly [the 401(k)] was performing before that,” Hansman said. “She’s still not 100% behind it but she said, ‘Just don’t lose everything. If you do I’ll divorce you.’ ”

 

In my view, Hansman makes a number of potential mistakes: trading expensive mutual funds instead of cheaper exchange traded funds; a home bias towards an employer in a sector (banking) that underperforms in a deleveraging (instead of using sector rotation); possible over-trading per month with higher transaction and execution costs; stocks that may have correlated returns and market beta exposures; and relying on swing trading without hedging. Handling his wife’s loss aversion and the potential, detrimental risks to his relationship are another matter: better invest in a copy of Diane Vaughan’s book Uncoupling: Turning Points In Intimate Relationships and a relationship therapist, just in case.

 

Neither Tokarev nor Hansman appear to have any background in finance or capital markets. Tokarev has a personal site with 401(k) day trading results.

 

Anxious Investors Day Trading With Retirement (LA Times)

 

Why Americans Won’t Day Trade Their 401K(s) (Felix Salmon)

 

Today in Awful Ideas: Day Trading With Your Retirement Fund (Gawker)

 

401(k) Day Trading (Vlad Tokarev)