Bad Retirement News

The LA Times reports that people are daytrading with their 401(k) retirement accounts. To phrase the point incorrectly, people are reacting to recent volatility by taking on riskier strategies. To phrase the point better, people are reacting to the need to earn high returns (because of past undersaving) by adopting riskier strategies.

There is evidence here for time-inconsistent utility functions and financial illiteracy to name just two economic topics.

Why is this bad? Because active traders tend to do worse than those who trade less frequently. To quote from just one paper (Odean, 1999)

The surprising finding
is that not only do the securities that these
investors buy not outperform the securities they
sell by enough to cover trading costs, but on
average the securities they buy underperform
those they sell. This is the case even when
trading is not apparently motivated by liquidity
demands, tax-loss selling, portfolio rebalancing,
or a move to lower-risk securities.
While investors’ overconfidence in the precision
of their information may contribute to this
finding, it is not sufficient to explain it. These
investors must be systematically misinterpreting
information available to them. They do not
simply misconstrue the precision of their information,
but its very meaning.

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