Speculating and Investing Are Not One and the Same
Author and Wall Street Journal columnist Jason Zweig talks trading trends and the future of the fiduciary standard.
On Morningstar's The Long View podcast, Jason Zweig examined the current trading terrain in the U.S. and discussed how to navigate current frenzies, speculative tendencies, and the recent distrust of expertise.
Talking about the need for a uniform fiduciary standard, Zweig discussed the benefits of creating a centralized, standardized licensing procedure for financial advisors. Zweig also offered his thoughts on the role temperament plays in investing success, stressing the significance of self-control, self-discipline, and lack of self-delusion.
Here are a few excerpts on access to trading, speculation, and the rejection of expertise from Zweig's conversation with Morningstar's Christine Benz and Jeff Ptak:
Christine Benz: You've referenced how trading has gotten easier. This seems like a positive change because it lowers barriers to entry and then allows some people into the market who might not have been able to be there before. But it seems dangerous, too, as you've alluded to. Have the removal of these frictions been a positive on balance?
Jason Zweig: Being able to trade for free is great, if you do it a few times a decade, or a few times a year, to be more realistic. But, if you're doing it a few times a day or a few times a week, it's terrible. Obviously, whatever you tax you get less of. And in the days when brokerage costs were much higher, people traded much less because it was like a tax. And there is zero evidence that people who trade more earn higher returns, and there is substantial evidence that the more you trade, the less money you'll make.
So, making trading cheaper, or making it free, is beneficial only for people who use it extremely rarely and judiciously. If you're going to shoot yourself in the foot, using a pistol is a much better idea than using a machine gun.
Jeff Ptak: Do you think the removal of these barriers and frictions has implications for the cost of capital in the kinds of returns investors can expect to earn in things like stocks and bonds?
Zweig: Yeah, I think it does. Elroy Dimson and his colleagues at London Business School and University of Cambridge have shown that the reduction in ownership costs and the ease of diversification that were brought about by the popularization of mutual funds in the second half of the 20th century almost certainly led to more-diversified portfolios, and a long-term rise in the valuation of the stock market--not just in the U.S., but globally. Although I think the best evidence is for the U.S.
So, the extent that free trading makes stock trading nearly universal, I think it would almost certainly lead to lower returns in the future. Not just because people will trade to their own detriment, but because a greater number of people will end up participating in the stock market as a whole.
Benz: One feature of the current trading frenzy is this instinct to be dismissive of experts: people like us who might say it's better to simply buy index funds and call it a day. What does expertise mean? And why have people become so distrustful of experts, not just in the investment context, but seemingly in other areas as well?
Zweig: Well, obviously, we can't disentangle that from broader trends in society. And we've seen this in the political realm, in economics, and in public health. I think some of it comes from the fact that anybody can Google anything and get a superficial understanding of even the most complicated issues, which is a new phenomenon. For most of human history, knowledge was the ultimate scarce good. A thousand years ago, 10,000 years ago, even a couple 100 years ago, most people knew almost nothing about the world outside the confines of their own home or village. But today, of course, with Google and other online tools, you carry an encyclopedia in your pocket that didn't exist a couple of decades ago, even a decade ago, for that matter.
But some of it, I think, also comes from the tendency of experts to overstate the certainty of their knowledge, to lead with overconfidence and lack of clear communication. If you look at COVID, it's almost the test case for why people distrust experts. Take the whole controversy about wearing masks, for example; it was confusing because the CDC gave mixed signals. Most people don't understand that one of the things that expertise means is to change your mind when new information comes in. People often confuse consistency with knowledge and expertise. They are under the belief that if you are an expert, you know the answer, and you never change the answer because you know it; when, in fact, to be an expert means that you change your mind frequently as new information comes in. That's what a good Bayesian does; that's what a person with common sense and good judgment does when new information comes in.
So, one of the key tests for whether somebody is an expert is whether they're willing to say, “I don't know,” or “I believe,” or “this is probable or likely,” rather than giving answers that are all about certainty.
Ptak: Let’s discuss one way in which the rejection of expertise is potentially expressing itself: how we're seeing young people invest. They're speculating, at least in some pockets. So, the question is, how do we help these younger investors transition from being speculators to adopting an investor mindset? I think one question that's come up is whether speculating and losing money is an essential part of the learning curve. What's your take?
Zweig: I wrote a column recently where I chastised The Wall Street Journal, my employer, for calling everyone an investor, even when many of the people we reflexively call investors are obviously traders at best and speculators at worst. That’s the first step for the financial media and all organizations that are involved in helping the public invest, which would include brokerage firms, mutual fund companies, financial advisors, asset managers of all types. Everyone has to get on the same page and reinforce the recognition that somebody who has made a couple of trades is not an investor just by dint of having made a couple of trades, any more than I'm a basketball player if I take a basketball and go out onto a basketball court. I'm someone who is playing basketball, but that doesn't make me a basketball player. Those distinctions are really critical. That's where I would start, and you always have to start with terminology. We have to define what it means to be an investor. And if you grab your phone, and you sign up for Robinhood, and you immediately trade as soon as you see the confetti, you're not by virtue of having done that an investor. So far, you're just a trader.
But, more importantly, there are structural changes that have to occur. For decades, the brokerage industry has supported something called the stock market game, which is typically presented in mass classes to young kids who are still in school, they are all pre-college kids. And the objective of the game is to earn the highest possible amount of money in an incredibly short period of time. This effectively teaches young kids to trade extremely volatile, high-risk stocks as fast as possible to earn the greatest amount of money in the shortest imaginable time. So, it's no surprise that when these kids become a few years older, the first thing they want to do is grab their phone and open a Robinhood account and start trading, because they've been taught by the brokerage industry that that's how you should invest.
If I could snap my fingers, I would make the stock market game disappear and I would replace it with a curriculum that focuses on compounding and principles of behavioral finance that teach young people about overconfidence and the illusion of control. So, we need to start with the definition of what it means to be an investor. And then we need to heal the ways we've gone wrong as a society in encouraging speculative behavior.