Day Trading in 2020: Did Free Trading Change Everything? (EP.160)

Episode Summary

Executive Summary: In episode 160 of the Rational Reminder Podcast, hosts Benjamin Felix and Cameron Passmore discuss a variety of financial topics. They analyze Simon Sinek's book 'The Infinite Game', examine Vanguard's move into direct indexing and CIBC's new Canadian Depositary Receipts (CDRs), and address a listener's detailed questions about bond allocations for early retirees. The main segment revisits day trading in the context of 2020, debunking the myth that free and app-based trading platforms improve individual investor outcomes. Citing recent academic papers on Robinhood users and smartphone trading, they show that these tools exacerbate herding, attention-driven buying of lottery-type stocks, and over-trading, leading to negative wealth effects. The segment concludes with reflections on market efficiency, arguing that meme stock mania does not break the efficient market hypothesis but rather reflects investor preferences that inform expected returns. The episode also features personal anecdotes and a 'Bad Advice of the Week' segment about a major Canadian bank's disclosure that it will not consider non-proprietary products for client recommendations.

Main Topics: Listener Questions on Bond Allocation for Early Retirement (Priority: 5/5): A detailed analysis of a listener's questions regarding the purpose of bonds in an early retirement portfolio, specifically focusing on the role of liquidity in crisis scenarios. The discussion covers the differences between government and corporate bonds, bullet versus barbell portfolio strategies (convexity), the impact of currency on bond selection, and the suitability of specific Canadian and U.S. Treasury ETFs. The speakers argue that if the primary goal is liquidity, short-term government bonds in the home currency are optimal, and they advise against over-engineering bond portfolios for most investors. Analysis of Recent Developments in Fintech and Market Structure (Priority: 4/5): An overview of two significant financial innovations: Vanguard's acquisition of JustInvest to enter the direct indexing space, and CIBC's launch of Canadian Depositary Receipts (CDRs) for single stocks like Amazon. The segment critically evaluates the value proposition of direct indexing for consumers and advisors, suggesting it may be a repackaged form of active management. For CDRs, the hosts note the convenience for Canadian investors but highlight the built-in fees for currency hedging and question the benefit for buy-and-hold, diversified investors. Day Trading in 2020: Does Free and App-Based Trading Improve Outcomes? (Priority: 5/5): The core segment of the episode revisits the profitability of day trading with updated 2020-2021 academic research. The hosts summarize findings from Barber and Odean's study on Robinhood data, which shows that attention-driven herding on the platform leads to negative wealth outcomes for the community. They also review a 2021 paper on smartphone investing, which finds that trading on a mobile app increases the probability of buying high-volatility, lottery-like stocks. The segment concludes that free trades do not eliminate costs (e.g., payment for order flow) and that the technological features of modern trading apps appear to harm rather than help individual investors. Book Review: 'The Infinite Game' by Simon Sinek (Priority: 2/5): Cameron Passmore shares his thoughts on 'The Infinite Game', contrasting its philosophy of long-term, purpose-driven leadership with the competitive 'winning' mindset presented in the previously reviewed book 'Playing to Win'. He explains how the book resonates with the hosts' approach to their own business, emphasizing resilience, a just cause, and a multi-generational perspective over short-term financial victories. Market Efficiency and Meme Stocks (Priority: 3/5): A brief discussion on whether the meme stock phenomenon and app-based herding has broken the efficient market hypothesis (EMH). Ben Felix argues that it has not, as the framework merely states that prices reflect available information. Meme stock mania is framed as an expression of investor preference, which affects prices and expected returns but does not invalidate the usefulness of price signals for making rational investment decisions.

Key Arguments: If liquidity in a crisis is the primary objective for a bond allocation, the optimal choice is short-term federal government bonds denominated in the investor's home currency. Corporate bonds and longer-duration bonds introduce unwanted credit risk and price volatility for this specific purpose. Academic research using Robinhood's trading data shows that attention-driven herding leads to negative wealth outcomes. The most popular stocks bought by Robinhood users underperform significantly in the following month, and the community as a whole loses about 5-6% during each herding event. Trading on a smartphone increases risk-seeking behavior. A 2021 study found a 67% increase in the probability of buying lottery-type stocks (high volatility, high positive skewness) when trades are made on a mobile app compared to a PC, and these trades trail the market by an average of 1% over the following 12 months. Free commission trading does not eliminate transaction costs. Platforms like Robinhood monetize through payment for order flow, which can result in worse execution for larger orders. The lower perceived cost of trading encourages higher turnover, which historically has been correlated with lower net returns. The growth of direct indexing, as seen with Vanguard's entry, is framed more as a compelling business proposition for advisors and asset gatherers than a strong value proposition for clients, given the limited and largely oversold benefits of tax-loss harvesting and customization. The 'Bad Advice of the Week' segment criticizes a major Canadian bank's client disclosure for explicitly stating it will not consider non-proprietary products, highlighting a clear and disclosed conflict of interest in the advisory relationship.

Data Points: Investor preference (SKU): 35% - The percentage of Robinhood users' net buying activity concentrated in only 10 stocks, compared to 24% for the general population of retail investors. Performance of Robinhood 'Top 0.5%' stocks: -4.7% - The average loss over the subsequent month for the top 0.5% of stocks bought by Robinhood users each day. Loss during herding events on Robinhood: 5-6% - The aggregate loss for the Robinhood community during each extreme herding event, with the 6% figure being market-adjusted. Increase in lottery-stock buying on smartphones: 67% - The increase in the probability of buying lottery-type stocks when trades are placed on a smartphone versus a PC, based on a 2021 study of German bank clients. Performance of smartphone trades: 1% trailing the market - Smartphone trades were found to trail the market by an average of 1% in the 12 months following the trade, alongside a lower Sharpe ratio. Trading volume comparison (Robinhood vs. competitors): 9x to 40x - In Q1 2020, Robinhood users traded 9 times as many shares as E-Trade customers and 40 times as many as Charles Schwab customers, per dollar in the average account. Cost of CDR currency hedging: 60 basis points annualized - The maximum annualized spread rate that CIBC can collect from foreign exchange transactions to manage the currency hedge for its new Canadian Depositary Receipts (CDRs).

Pivotal Quotes: "Their findings suggest that extreme herding causes negative wealth outcomes for the overall Robinhood community." — Benjamin Felix: Summarizing the key finding from the Barber and Odean 2020 paper on attention-induced trading using Robinhood data, illustrating the collective financial harm caused by the herding behavior on the platform. "If you're an advisor that's just starting out and you have to get a hundred and fifty thousand dollars in assets to survive, you're not playing the infinite game. And that's the challenge. The book is about the ideal state, not the practical state." — Cameron Passmore: Reflecting on the practicality of Simon Sinek's 'Infinite Game' concept in the real world of financial advising, acknowledging the tension between long-term ideals and short-term business survival needs. "I think a liquidity sleeve implies a market timing decision because you're effectively increasing your exposure to equities after a crash by spending fixed income without rebalancing. And that's something that just doesn't make a whole lot of sense to me." — Benjamin Felix: Critiquing the listener's premise for holding bonds as a 'liquidity sleeve' for market timing, arguing that drawing down bonds without rebalancing back to target is an implicit form of market timing that he finds unconvincing.

Implications: For investors, the episode reinforces that new trading technologies and social platforms likely worsen behavioral biases, making it harder to profit from day trading. The efficient market focus on price informativeness remains valid even during meme-stock episodes. For advisors, the 'Infinite Game' mindset and the bank disclosure example underscore the importance of aligning business models with long-term client interests, not just short-term product sales.