The media storm over Michael Lewis and his new book about high-frequency trading is fascinating to watch — and of remarkably little consequence. Serious retirement savers are not affected by flash trading and, quite possibly, benefit from its existence.
Lewis is a great writer. I suppose his publisher welcomes the attention the book has gotten and loves the fact that Lewis is willing to debate traders on TV about the book’s main charge, that high-frequency programs manipulate the markets.
Here’s the thing: It doesn’t matter to you and me. Yes, if you are in the business of trying to make money on short-term hunches, the flash boys are your competitors and you’re likely to get screwed. But that’s very few investors.
If like millions of retirement investors you instead buy an index ETF holding hundreds or thousands of stocks and bonds, there’s no “high-frequency tax” on your money. That’s because there’s virtually no trading going on.
Consider a big, passive, index-style fund, say one run by Vanguard. If you look inside the Vanguard Total Stock Market ETF (VTI), what do you see? For starters, you will find 3,629 individual stocks. You’ll also find an extremely low turnover rate, just 4.3%.
The managers of VTI might go up against a flash boy once in a blue moon while trying to adjust a position in Apple or ExxonMobil to match an index weighting. Maybe they’re exposed to some risk there, but it’s a level that’s pretty close to a vanishing point.
As John Bogle, the founder of Vanguard, points out, we’re better off with high-frequency traders in the market than without them. Market-making is as old as the hills. It has gotten faster and more brutal for those disposed to play that game, but the net effect — more liquidity, and thus more accurate price-setting — is not a bad thing.
At the end of the day, index funds mimic a benchmark. If a broad-market ETF were being taxed by high-frequency trading, a fund such as the SPDR S&P 500 (SPY) soon would fail to keep up with the S&P 500 Index. Investors would leave the ETF in droves. That isn’t happening now, and it won’t happen in the future.
The second reason I don’t care is that even if you are disposed to trade there’s a simple solution: Use a limit order. If you want to buy XYZ Inc. at $20.60 cents, put in an order at that price, make it good-til-canceled and forget about it.
The price might be erratic as the high-frequency types push around the Wall Street trading desks, trying to nick them for pennies here and there. In time, however, your order is likely to be filled at your price and that’s that. There’s no reason to chase a stock at all.
The last reason I don’t care is that worrying about high-frequency traders is missing the forest for the trees. The truly huge cost to long-term investors is all the fees they pay for active management.
A real worry
You will lose, guaranteed, between 30% and 50% of your potential gains after paying all those stiff mutual fund fees and advisory wrap fees on top. You want to worry about something real? Worry about that.
I’m sure Flash Boys tells a gripping story, as all of Lewis’s books do, but when it comes to retirement investing the best way to get around the “problem” of high-speed trading is to own an index fund, not an actively managed fund.
Active funds are in the business of picking fights with the flash boys with your money, all the while raking fixed fees out of your account regardless of outcome. The whole issue is just another good reason to avoid active management completely.