Fool.com: Converting to Foolishness [Fool on the Hill] January 15, 1999

FOOL ON THE HILL: An Investment Opinion
Converting to Foolishness

By Warren Gump (TMF Gump)
January 15, 1999

Buy and hold. The mantra of The Motley Fool. Find great companies, invest in their stocks, hold onto them over the years, and watch them grow. No need to pull out your checkbook to pay Uncle Sam taxes on capital gains. Instead of paying brokerage commissions, all of your money stays invested, earning more for you. It makes so much sense and should be so easy. For me, however, it has been tough to implement this simple strategy. You see, I'm a recovering trader and relatively new Fool. To help me become more Foolish, I have made one financial resolution for 1999.

Before discussing my plan for the new year, I should fill you in a little bit on my background. While having successfully invested money in dividend reinvestment plans since college, an increasing portion of my portfolio was being allocated to my trading account. Before finding the Fool, I would have been excited to read How to Get Started in Electronic Day Trading: Everything You Need to Know to Win in Wall Street's Hottest Game. It would have helped me bring my average holding period down to several hours from several months.

Part of my decision to become a Fool was a desire to reduce, if not eliminate, my trading habit. This strategic shift was not prompted by bad performance. While some of my early years of investing were erratic (yes, folks, that's a euphemism for poor), the past few have been quite good. These results come compliments of a raging bull market and a couple of extremely successful speculative bets.

When executing a trading-oriented strategy, however, it isn't enough to just stay abreast of news when its convenient. You must always be on top of market activity. I would call in at least three or four times a day for market updates when away from work. During a vacation to bucolic South Carolina, I hesitated to go out during the day because of my draw to CNBC. The channel not only allowed me to track the market, but also it provided an opportunity to further develop my (one-way) friendship with Mark Haines, David Faber, Joe Kernen, and Maria Bartiromo. How pathetic one's life can become!

Okay, okay. It wasn't just that I wanted to get my life back. Passing along a significant portion of my profits to Uncle Sam, as well as the State and City of New York, cut my returns noticeably. Due to the payout these "partners" demand, my (pretax) market-beating returns sometimes became market-lagging gains.

How is this so? The total tax rate on short-term gains for someone in the 28% federal bracket is a bit over 40% in New York City after state and local taxes are included. Assuming 100% short-term portfolio turnover, a taxable trader's net return on a 42% pretax gain is much less impressive (and last year, a market-lagging) 25%. A buy and hold strategy, on the other hand, keeps the government at bay so your gains can compound and make even more money.

Having traded for so long, however, it is a struggle to stop. How many gambling addicts do you know that are working at a casino? Quarterly earnings news, "big" new product developments, and monthly chain-store sales are a few of the pieces of information I used to trade on. As a Fool writer, I still see this kind of information every day. While I have improved my ability to suppress trading on some news, some ideas have proven too tantalizing and I couldn't resist getting involved in the action. (The Fool's policy requiring employees to hold onto securities for at least 30 days has kept me out of certain ideas.)

To squelch the final remnants of my trading habits, I am going to only buy stocks during four "buying periods" in 1999. Instead of purchasing a security whenever one "seems to be a great buy" (and money is available), I'm only going to buy stocks during the last week of February, May, August, and November. This point in the quarter was consciously picked because it is usually fairly quiet, as the quarterly earnings season has wound down. By making purchase decisions during this "quiet time," my focus will be on the long-term underlying economic fundamentals of the companies rather than short-term hype and hysteria.

I have created a watch list to track the stocks that pop onto my radar screen outside of these buying periods. Each quarter, in preparation of a buy decision, I'll closely evaluate the merits of the companies on this list with the brightest long-term prospects. By narrowing my purchase selections from a pool of appealing companies, I will be forced to thoroughly compare each one. This should result in only taking a stake in the creme-de-la-creme of my ideas. Hopefully, the companies in my portfolio will be so strong that I will often find myself adding to positions I already own.

Since it can be so much fun (and sometime extremely profitable) to speculate on "wild ideas," I am giving myself a little out. I have set aside a small portion of my IRA (where capital gains are tax-deferred) as "funny money" that is not subject to the above restrictions. I can do whatever I want with this money, whether Foolish or Wise. I can trade, speculate, or do anything else. But only with this money. If it grows, I'll have more to play with. If not, that's it. No more funny money until next year. This money will give my more unusual ideas a venue to perform and also provide a live laboratory for me to experiment with innovative investing strategies.

I expect to become a better investor and increase my long-term after-tax returns because of this more stringent buying process. Admittedly, it borders on the absurd to be so consumed with trading that a buying restriction like this is necessary. At the same time, who cares if it improves my investment performance?

Beyond higher returns, I anticipate having more time to enjoy the many pleasures of living. No longer will I be glued to CNBC or the Internet to follow the market on an hourly basis. I can instead spend time with friends and family, climb mountains, raft rivers, watch theater, volunteer, and participate in the many other pleasures of life. Making money isn't an end in itself, it's a means to a more enjoyable life. Now that's Foolish!