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Tuesday, October 20, 1998

An Investment Opinion
by Dale Wettlaufer

Thoughts on an NAIC Conference

Having just returned from a few days at a National Association of Investors Corp. (NAIC) conference in San Jose, I wanted to share a few observations. These are somewhat random and are not ordered by importance.

1. Individual investors are generally smart people.

Take out the people who expect 25% market growth until Judgment Day (and this is a remediable thought, anyway) and the couple of odd balls who talk your ear off about their latest trading system and you've got a pretty intelligent group of people who attend these conferences. First, the decision to invest excess personal earnings (I refuse to call it savings, because that confuses the terms "saving" and "investing") is a smart one to begin with. It's a heck of a lot smarter to plug retirement money into good common stocks rather than Treasury obligations any day of the week. Even when the market is frothy, it's a smarter decision to make. That is, provided you don't extend logic too far and believe that any company at any price is a good investment just because you're a buy-and-hold investor.

2. Individual investors are smarter than the Vice-Chairman of Merrill Lynch believes.

I still haven't received a reply to my open letter to Merrill Lynch, by the way. To bring people up to speed, Merrill Lynch Vice-Chairman John Steffens thinks that individuals who use discount online brokerages are endangering themselves by doing so. No doubt Mr. Steffens thinks that a Merrill broker can do better for people. What's so funny and just totally absurd about his statement is that Merrill Lynch's equity mutual funds don't do any better than a random sample of individual investors surveyed by University of California (Davis) professors Brad M. Barber and Terrance Odean. We're talking about gross return here. Now add in expenses. Both individuals and funds have them, whether it's in explicit expenses for subscriptions or implicit expenses for soft dollars that mutual funds pay. The soft dollars show up in the turnover of the professionally run portfolio. Now add in Merrill's fat 5% load and John Steffens's top pros actually lose to a random set of individuals.

Even more interesting, if you educate a group of people about investing, these "average Americans" start to whip the pros. The average holding period among NAIC investors is seven years -- which translates into a yearly portfolio turnover of roughly 14%. Your average mutual fund turns over the portfolio about 77% per year, which works out to an average holding period of 1.3 years. The same conclusion that the UC Davis professors come to, that "the well-documented tendency for human beings to be overconfident can best explain the high trading levels and the resulting poor performance of individual investors" probably extends to the suits on Wall Street.

Also, and this is just a repeat of earlier arguments on this point, guys like John Steffens should wake up and realize that "average Americans" with experience running a tire distributorship, running their own or their spouse's medical practice, running the books of a charity organization, balancing a family's finances, or myriad other small businesses are not bozos. You don't survive running a couple of tire shops that do 3% pre-tax by being a dummy, and you probably have a hell of a lot more horse-trading sense about business than some newly minted MBA. I met a lot of very savvy people at the NAIC conference that probably can't do a discounted cash flow spreadsheet, but who could tell you what it takes to actually run a company.

3. Young people should realize the value of investing sooner in their lives.

I heard from a number of parents and grandparents at the show that they wish there were a way to make their kids understand the value of investing earlier in life. I didn't have an easy answer to that one, but I believe as many people here believe that schools should have a better curriculum for educating kids about personal finance. Currently, most curricula take the form of short-term stock picking contests that start and wrap up in the course of a half-year, which is anywhere from being marginally useful to harmful to kids' perceptions about what the stock market is. It's not a game to determine who can rack up the biggest short-term gains. You might as well take the kids to the casino on a field trip, because teachers who design courses like this are reinforcing the notion that the stock market is for speculation and not for rational long-term decision-making.

4. Companies have to wake up.

Don't lock individuals out of your conference call replays. Could someone please email me and tell me the logic of locking out an owner of the company from one of four quarterly updates while letting someone in on the conference call who doesn't own the stock, who may not represent anyone owning the stock, or who even might be short the stock? That's not logical. If educated individuals are far more apt to hold a stock than a mutual fund, then it's common sense that that's the type of investor you want. If you believe in the capital asset pricing model, too, that sort of investor is also going to lower your cost of equity, all else being equal.

Some companies have told me that they want the investors on the line that are going to buy the stock. Great, but what happens when the company misses quarterly earnings estimates or experiences a temporary blip in results? A rational investor is MUCH less likely to push the sell button than the mutual fund manager who wants to lock in his or her year or is looking for every "performance" edge.

Overall, I was extremely impressed by people at the NAIC convention. These are investors who aren't the amphetamine-driven SOES traders that people like John Steffens must imagine them to be. They're rational Moms and Dads, business owners, retirees, and genuinely hard-working Americans that are doing the most intelligent and businesslike thing with their excess earnings. Commission-driven brokers and hyperactive fund managers should take note and maybe get out and learn something from these people.