Every physician investor has at one time or another considered trying their hand at trading. Maybe their friends work on Wall Street, or they watch CNBC’s Fast Money, or they were inspired by Dr. Michael Burry on the Big Short. And of course, its hard to go to a cocktail party and not hear about someone making a hugely profitable trade. But take it from a former Wall Street trader that doctors shouldn’t trade. Here’s why:
1. No Trading Edge Compared to Professionals
There is big money being thrown around on Wall Street, which means there are some very smart people working on Wall Street trying to make money. Doctors are smart, but we can’t compete against these equally highly educated hedge fund managers who have an army of research analysts giving them an edge in fundamental analysis, the fastest computers to give them a technical edge in trade execution, and the years of experience of living and breathing the markets 24/7.
2. Differential Between Short and Long-Term Trading Tax Implications
The IRS encourages long-term investing and discourages short-term trading by taxing short-term and long-term capital gains at different rates. Short-term trading profits are taxed as ordinary income, which for physicians can be as high as 39.6%. Long-term capital gains (defined as investments held for longer than 1 year) are taxed at a lower rate (15-20%). This 20% difference in tax rates makes it even harder for traders to beat long-term investors. If you make 8% in your index fund portfolio, you would need to make at least 10% in your trading portfolio to make the same after-tax return if you are in the highest tax bracket.
This disadvantage can be mitigated by trading in your retirement account, but it is counterintuitive to be trying to make short-term money for an account that you can’t withdraw from without penalty until retirement age, which could be 20-30 years in the future.
3. Chance of taking way too much risk
Traders must be disciplined, and be meticulous in their risk management skills. Trading websites often cite risk management as the most important skill of trading. Poor risk management, they say, can ruin even profitable traders. Doctors trying their hand out in trading may not fully appreciate the importance of risk management, and just throw 5%, 10%, or even 20% of their portfolio on a single stock.
In addition, there is always a risk that short-term “trading” eventually just becomes gambling, with the goal simply of getting the rush of a winning trade. As such, there is a danger, especially for a losing trader, that larger and larger portions of a portfolio are allocated to trading in order to make back money lost or to have some winning trades. It is better just to never start.
4. Bid-Ask Spread and Trading Commissions
It costs money to play in the stock market. Brokerage houses make money by charging a commission for each trade you make. For stocks, Fidelity charges $7.95 per trade, and Vanguard charges up to $7.95 per trade, depending on the size of your portfolio. A short-term trader who trades just once per day (250 trades a year) would pay Fidelity approximately $2,000 in commissions yearly. For a physician allocating $100,000 to their trading account, this is already 2% of their portfolio.
This doesn’t even include the bid-ask spread, which is how investment banks and market makers (or mostly their computers) make money off of traders. Market makers will offer retail traders a price they are willing to buy a stock at (the bid) and a price they are willing to sell a stock at (the ask). For example, they might be willing to buy a stock for $10.00 and sell it for $10.05. The difference between the bid price and the ask price is the bid-ask spread (in this case $0.05) and is the profit the market makers earn to create a liquid market. Bid-ask spreads are smaller for more popular, higher-volume stocks, and lower for less popular, lower-volume stocks. A typically bid-ask spread for a high-volume stock might be $0.01 for a $100.00 stock, or 0.01%. Again, if you trade in and out of this stock 50 times (100 trades), losses from the bid-ask spread alone approaches 0.5%, which would be unacceptably high if this were a management fee.
By investing in index mutual funds, there is no trading commission and no big-ask spread. If you prefer ETFs over mutual funds, many index ETFs are commission-free with Fidelity and Vanguard, and the trading volume of these ETFs make the bid-ask spread minuscule. Also, you are trading much less often.
5. Time Commitment Required to Succeed
It takes time to trade well. Remember, you are competing against professionals who have been studying the markets full-time for years, with research analysts to back them up. It’s unlikely that you would be able to beat the market in your spare time. You aren’t going to beat the market during your lunch break, or even by doing 1 hour of homework per stock a week, as Jim Cramer recommends. Dr. Michael Burry from the Big Short attributes his success to poring over financial statements during quiet hours on call. Eventually it became an obsession for him, and he no longer works as a neurologist in order to focus on his hedge fund. Success in trading requires a commitment far beyond what a full-time physician can give.
6. Rarely Beat the Market
Many traders make money in the short-run. Probability states as much. If you flip a coin, with half of investors betting on heads, and half betting on tails, 50% of investors will be making money. These 50% will brag to their friends about their winning trade, or post on message boards touting their investment returns. This is dangerous, because it can lure traders into thinking that they are beating the market, when in actuality, luck has been on their side. In the long-run, very few traders will be able to consistently make money, especially taking into account the structural disadvantages of the bid-ask spread, trading commissions, and unfavorable tax treatment of short-term capital gains.
7. Take Uncompensated Risk
Trading by definition will lead you to hold an undiversified portfolio. This means that you will be taking outsize risk for the same expected gains. Diversification is one of the only free lunches in investing, and by trading you are not taking that free benefit. The expected return of the average individual stock does not exceed the market (otherwise everyone would pile into the highest return stocks), but the standard deviation of returns of an individual stock far exceeds that of the market.
8. Stress of Losing Money
Trading is stressful. Even if you make money, it is stressful. The daily gyrations of the market cannot be controlled, and if your money is at risk, it is stressful. I would argue that trading can be more stressful than most physician jobs (exceptions would probably be emergency medicine or surgery). Being a doctor is stressful enough; there is no reason to allow investing to add any more stress to our lives.
Hopefully, I’ve been able to convince you that trading is a losing proposition. Have you ever traded stocks and had success? Do you have any additional reasons why you shouldn’t trade? Comment below!