Invest With an Edge

In almost everything we do, we try to get an advantage, some way of beating the competition. If you happen to be taller than your buddies, you'll probably have an edge in a pickup game of basketball. If you are ruthless and put hotels on all the green properties, you'll probably win at Monopoly. (Just try not to do this when playing the kids, OK? You'll look ridiculous doing a victory dance around the table.)

When we invest, it's no different. To gain an advantage, maybe we should watch investment programs like those on CNBC. That will give us an edge, right? Heck, On the Money even says this up front. According to its website, the show and host will "keep you one step ahead of what people will be talking about and investing in tomorrow." Hmm. Maybe not. Following television doesn't seem like the path to riches to me. After all, they have to keep things exciting so people will watch and advertisers will pay.

What if we follow the analysts and take advantage of their expertise? Their job is to keep track of the market and how different companies are doing throughout the year. That is supposed to give the investor following them an edge over those who don't. I don't know about you, but I don't have time to watch things that closely, so I want all the help I can get.

The tale of the tape
Let's see whether that works. Suppose we had invested $1,000 in each of the following companies, or as near as could be managed, back on March 1, 2002, and then did exactly what the analysts told us. When one downgraded, even from "buy" to "hold" -- "peer-perform," "market weight," whatever -- we sold. (Really, is anyone confused by a downgrade to "hold"? It means "sell.") We'd then wait until an analyst upgraded the stock before we'd buy. Then we'd sell at the next downgrade, and so on. After all, the analysts' entire job is to keep a careful eye on the companies, right?

Each trade would cost us $10 in commissions. After a sale, only the net proceeds would be available for the next buy (no fair bringing it back up to $1,000 if we happen to dip below that). How much money would we have, from March 1, 2002, through the end of last February, exactly five years later? And how much money would we have if we had just held on?

Following the advised buys and sells doesn't seem to give much of an edge at all, does it? In fact, the opposite seems to be mostly true. Note that these results do not take taxes into consideration. If we invested in the same way, but outside a tax-advantaged account, the differences would have been even larger.

Where's our edge?
Bad things like the China meltdown happen in the market. Each of the companies listed above suffered at least one drop of 25% or more during those five years; four of them saw a decline of more than 40%. The analysts were there all the while, cheering us on to buy or sell. But we do not have to play frog and jump whenever the analysts tell us to hop. Phelps Dodge has had six downgrades since last September, even while the stock has risen more than 45%. Hopping to that tune may strengthen our leg muscles, but it does nothing to fatten our portfolios.

So what can we do? Peter Lynch noted in One Up on Wall Street, "Most of the money I make is in the third or fourth year that I own something. ... If all's right with the company, and whatever attracted me in the first place hasn't changed, then I'm confident that sooner or later my patience will be rewarded."

That's it? Wait -- anyone can do that. However, it's tougher than it sounds, especially when an analyst downgrades the company and the price drops 5% in one day or the whole market sinks like a junk with a hole in the hull. Successful investors like Warren Buffett and Peter Lynch ignore such movement, using patience to help them get great returns. Bill Nygren wrote, "We are patient investors, not market timers." His Oakmark fund has seen annual average returns of 15.4% for nearly 16 years. Practicing patience can be just the edge you are looking for.

Try this edge
Of course, that patience should be used after buying solid companies. If that's where you struggle, we can help. In Tom and David Gardner's joint newsletter service, Motley Fool Stock Advisor, they've been recommending solid businesses for five years. They follow Peter Lynch's advice and have the patience to hold on. In fact, three to five years is expected to be the minimum holding time.

If things change for the worse, though, they aren't afraid to sell. What they don't do is respond to every bit of news, giving rapid-fire buy or sell calls. As we've seen, that is probably not the best way to success. So far, the edge from practicing patience has resulted in beating the S&P 500 index by more than 35 points. Give the service a free 30-day trial and see if that edge will work for you.

Fool contributor Jim Mueller does not own shares in any company mentioned. Electronic Arts is a Stock Advisor recommendation and Intel has been tagged at Inside Value. We think our disclosure policy gives us such a sharp edge, it hurts.