Is Day Trading in Your IRA a Good Idea?

By Clifton Linton
Senior Writer, mPower

In This Story An Investment Moral Two Strikes If You Gotta Do It Think Like a Pro

From all of the hoopla surrounding it, day trading seems to be a way to make a quick buck. What better way to quickly build your retirement portfolio? That's the wrong attitude to take, financial planners say.

Your retirement portfolio is the foundation that will provide for you in your later years. You don't want to use a risky investment strategy that opens you up to potentially big losses.

minute: read this article at a glance.

Technical Terms NAV Exchange-traded fund Asset allocation

Financial planner Ed Slott has a client, a retiree, who fashions himself as the next George Soros. This client, a former garment maker, has a seven-digit balance in his IRA and an itch to day trade the money.

"He's a wheeler-dealer," said Slott, who declined to name the client.

Needless to say, the client's wife was worried. She fretted that her husband might fritter away their retirement nest egg in the stock market, said Slott, a CPA and editor of Ed Slott's IRA Advisor. "She was right. If he lost the money, what would they do ...," he said.

With toll free numbers and/or Internet access to easily change account asset allocation, and folks looking to get rich quick, the temptation is greater than ever for folks to day trade the market with their IRAs.

Day trading entails moving in and out of investments frequently, often several times a day, seeking quick profits.

But, day trading isn't a sound strategy to build your retirement balance, financial planners say.

"I don't believe in day trading at all. I've never seen anyone make any money at it," said Certified Financial Planner Ben Utley, founder of Utley & Associates of Eugene, Ore.

An Investment Moral

Many of you may recall the fable of the tortoise and the hare. Its moral (slow and steady wins the race) is particularly appropriate for retirement saving.

Take the cautionary tale Gary Learned, 52, recounts. Even though it's about an employer-sponsored plan, the point it illustrates could just as easily be applied to IRAs.

One of Learned's co-workers at GE Co. readjusted his employer-sponsored retirement portfolio at each of the 12 investment changes allowed per year. "He switches in and out of GE stock, based on what he thinks the stock will do," Learned said.

Sometimes, his friend has done well. Sometimes not. "I saw him get caught short," and lose several thousand dollars, Learned said.

"Your retirement should clearly be a long-term investment. Day trading doesn't fit that category." — Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri.

"Your retirement should clearly be a long-term investment," said Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri. "Day trading doesn't fit that category."

How long is long term? About 30 to 40 years, said David Wray, president of the Profit Sharing/401(k) Council of America. "Long-term investing is a consistent investment decision. You make a ... plan and stick with it. It's not about making (snap) judgement," he said.

The reason to employ a sound asset allocation strategy in the first place is because most of us can't read a crystal ball and pick the next market winner. By using a balanced allocation approach, you will be saved from the pressure of trying to pick the next hot sector or stock. Also, by hopping around, you may miss out on some big returns, as the chart below shows.

"We (investors) need to have money bet on every horse in the race. We never know who's going to win before the race starts," Weagley said.

When you day trade, you're often placing a one-time bet on one specific security. If you win, you could win big. If you lose, you could lose big. Consequently, you could be substantially increasing the risk in your portfolio.

While long-term investing isn't terribly exciting, over time the steady returns this strategy can generate stand a good chance of beating the more volatile results from day trading, financial planners say.

Utley urges his clients to think of their retirement portfolio as being their own business. "The good ones make money. But, businesses aren't exciting every day," he said.

The moral: Once you've set up your investment strategy, leave it alone.

Two Strikes

Folks thinking about day trading their IRA should realize that they have two factors stacked against them, Utley said.

"If 7,000 pros on Wall Street can't do it, someone who (just) learned how a limit order works shouldn't do it." — Ben Utley, certified financial planner and founder of Utley & Associates of Eugene, Ore.

The first is that even the professional fund managers shun day trading. Case in point, there's no "day trading" mutual fund. "If 7,000 pros on Wall Street can't do it, someone who (just) learned how a limit order works shouldn't do it," Utley said.

The second strike against day trading is high trading fees. "Transaction costs will eat you alive," he said.

That's particularly true with self-directed IRAs. Most of these accounts charge an annual maintenance fee and transaction fees. Suppose you have a brokerage window account with a discount broker that charges a $10 per transaction commission. That means any trade you make must appreciate $20 before you make a profit (to offset the $10 fee to sell and the $10 fee to buy something else).

It's impossible to day trade a mutual fund. Mutual fund prices are set once a day, at the end of trading, when the fund company runs what is known as the net asset value or NAV. Of course, you could day trade market indexes by buying and selling exchange-traded funds such as SPDRs (Spiders), which track the Standard & Poor's 500 Index, or Diamonds, which track the Dow Jones Industrial Average. But, again, financial planners discourage this strategy because you are chasing funds that are currently the hottest.

Chasing after hot performers usually results in "inferior performance," Weagley said.

If You Gotta Do It

"Yeah, yeah," you say. "I'm careful. And I'm not those losers."

Financial planners realize many investors do have the urge to trade. So, they suggest opening a trading account outside your retirement plan. If you don't have the means to do this, trade with a small enough proportion of the money inside your IRA that you won't irrevocably hurt your portfolio should you make a bad investment.

When Slott's client's wife said she was worried that her husband might trade away their retirement nest egg, the three sat down and worked out a solution. They took about 10 percent of the portfolio and set it aside for the husband to use as "play money." By exclusively limiting his trading funds to a limited amount, he wouldn't touch the bulk of his retirement portfolio.

"That seemed to work," Slott said. "That kept his wife happy."

Think Like a Pro

Whether you're planning to day trade or to take the slow-but-steady approach, you will stand a greater chance of success in reaching your retirement dreams if you think and act like a professional money manager.

These guys don't buy or sell a stock on a whim. One of the signs of respectable money managers is that they don't act emotionally toward the money they oversee. "Emotion is the enemy of all good investors," Utley said.

Separating from emotion is hard to do. That's why professional investors conduct thorough research. That means keeping up on the news of their investments and making logical, fiscally responsible choices.

Related Reading The Value of Asset Allocation Boost Your IRA Returns by Rebalancing Your Guide to Understanding IRA Fees

Indeed, when Utley's clients come to him with a hot investment tip, he doesn't scoff. "I take them (the tips) as a starting point," he said.

He checks out earnings and the company's business model. He takes time to reflect on the investment, then decides whether it makes sense or not. "My thought is that there has never been a quality fiduciary decision that was made in haste," Utley said. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Is Day Trading in Your IRA a Good Idea?

By Clifton Linton
Senior Writer, mPower

In This Story An Investment Moral Two Strikes If You Gotta Do It Think Like a Pro

From all of the hoopla surrounding it, day trading seems to be a way to make a quick buck. What better way to quickly build your retirement portfolio? That's the wrong attitude to take, financial planners say.

Your retirement portfolio is the foundation that will provide for you in your later years. You don't want to use a risky investment strategy that opens you up to potentially big losses.

minute: read this article at a glance.

Technical Terms NAV Exchange-traded fund Asset allocation

Financial planner Ed Slott has a client, a retiree, who fashions himself as the next George Soros. This client, a former garment maker, has a seven-digit balance in his IRA and an itch to day trade the money.

"He's a wheeler-dealer," said Slott, who declined to name the client.

Needless to say, the client's wife was worried. She fretted that her husband might fritter away their retirement nest egg in the stock market, said Slott, a CPA and editor of Ed Slott's IRA Advisor. "She was right. If he lost the money, what would they do ...," he said.

With toll free numbers and/or Internet access to easily change account asset allocation, and folks looking to get rich quick, the temptation is greater than ever for folks to day trade the market with their IRAs.

Day trading entails moving in and out of investments frequently, often several times a day, seeking quick profits.

But, day trading isn't a sound strategy to build your retirement balance, financial planners say.

"I don't believe in day trading at all. I've never seen anyone make any money at it," said Certified Financial Planner Ben Utley, founder of Utley & Associates of Eugene, Ore.

An Investment Moral

Many of you may recall the fable of the tortoise and the hare. Its moral (slow and steady wins the race) is particularly appropriate for retirement saving.

Take the cautionary tale Gary Learned, 52, recounts. Even though it's about an employer-sponsored plan, the point it illustrates could just as easily be applied to IRAs.

One of Learned's co-workers at GE Co. readjusted his employer-sponsored retirement portfolio at each of the 12 investment changes allowed per year. "He switches in and out of GE stock, based on what he thinks the stock will do," Learned said.

Sometimes, his friend has done well. Sometimes not. "I saw him get caught short," and lose several thousand dollars, Learned said.

"Your retirement should clearly be a long-term investment. Day trading doesn't fit that category." — Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri.

"Your retirement should clearly be a long-term investment," said Robert Weagley, a certified financial planner and associate professor of consumer and family economics at the University of Missouri. "Day trading doesn't fit that category."

How long is long term? About 30 to 40 years, said David Wray, president of the Profit Sharing/401(k) Council of America. "Long-term investing is a consistent investment decision. You make a ... plan and stick with it. It's not about making (snap) judgement," he said.

The reason to employ a sound asset allocation strategy in the first place is because most of us can't read a crystal ball and pick the next market winner. By using a balanced allocation approach, you will be saved from the pressure of trying to pick the next hot sector or stock. Also, by hopping around, you may miss out on some big returns, as the chart below shows.

"We (investors) need to have money bet on every horse in the race. We never know who's going to win before the race starts," Weagley said.

When you day trade, you're often placing a one-time bet on one specific security. If you win, you could win big. If you lose, you could lose big. Consequently, you could be substantially increasing the risk in your portfolio.

While long-term investing isn't terribly exciting, over time the steady returns this strategy can generate stand a good chance of beating the more volatile results from day trading, financial planners say.

Utley urges his clients to think of their retirement portfolio as being their own business. "The good ones make money. But, businesses aren't exciting every day," he said.

The moral: Once you've set up your investment strategy, leave it alone.

Two Strikes

Folks thinking about day trading their IRA should realize that they have two factors stacked against them, Utley said.

"If 7,000 pros on Wall Street can't do it, someone who (just) learned how a limit order works shouldn't do it." — Ben Utley, certified financial planner and founder of Utley & Associates of Eugene, Ore.

The first is that even the professional fund managers shun day trading. Case in point, there's no "day trading" mutual fund. "If 7,000 pros on Wall Street can't do it, someone who (just) learned how a limit order works shouldn't do it," Utley said.

The second strike against day trading is high trading fees. "Transaction costs will eat you alive," he said.

That's particularly true with self-directed IRAs. Most of these accounts charge an annual maintenance fee and transaction fees. Suppose you have a brokerage window account with a discount broker that charges a $10 per transaction commission. That means any trade you make must appreciate $20 before you make a profit (to offset the $10 fee to sell and the $10 fee to buy something else).

It's impossible to day trade a mutual fund. Mutual fund prices are set once a day, at the end of trading, when the fund company runs what is known as the net asset value or NAV. Of course, you could day trade market indexes by buying and selling exchange-traded funds such as SPDRs (Spiders), which track the Standard & Poor's 500 Index, or Diamonds, which track the Dow Jones Industrial Average. But, again, financial planners discourage this strategy because you are chasing funds that are currently the hottest.

Chasing after hot performers usually results in "inferior performance," Weagley said.

If You Gotta Do It

"Yeah, yeah," you say. "I'm careful. And I'm not those losers."

Financial planners realize many investors do have the urge to trade. So, they suggest opening a trading account outside your retirement plan. If you don't have the means to do this, trade with a small enough proportion of the money inside your IRA that you won't irrevocably hurt your portfolio should you make a bad investment.

When Slott's client's wife said she was worried that her husband might trade away their retirement nest egg, the three sat down and worked out a solution. They took about 10 percent of the portfolio and set it aside for the husband to use as "play money." By exclusively limiting his trading funds to a limited amount, he wouldn't touch the bulk of his retirement portfolio.

"That seemed to work," Slott said. "That kept his wife happy."

Think Like a Pro

Whether you're planning to day trade or to take the slow-but-steady approach, you will stand a greater chance of success in reaching your retirement dreams if you think and act like a professional money manager.

These guys don't buy or sell a stock on a whim. One of the signs of respectable money managers is that they don't act emotionally toward the money they oversee. "Emotion is the enemy of all good investors," Utley said.

Separating from emotion is hard to do. That's why professional investors conduct thorough research. That means keeping up on the news of their investments and making logical, fiscally responsible choices.

Related Reading The Value of Asset Allocation Boost Your IRA Returns by Rebalancing Your Guide to Understanding IRA Fees

Indeed, when Utley's clients come to him with a hot investment tip, he doesn't scoff. "I take them (the tips) as a starting point," he said.

He checks out earnings and the company's business model. He takes time to reflect on the investment, then decides whether it makes sense or not. "My thought is that there has never been a quality fiduciary decision that was made in haste," Utley said. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.