The stock market is fundamentally different from what it was a decade ago. The Internet, frankly, changed everything.
We take it for granted now, but the Web democratized the buying and selling of stocks in an unprecedented way.
Party at the moon tower
Equities, for one, have become more accessible in two ways:
- Internet-based discount brokerages provide a dirt cheap alternative to buying stocks through very costly full-service brokerages. Not only are investors saving money on commissions in general, but we're also able to buy shares in small lots and still keep commissions to less than 2% of our investment.
- The volume of information on stocks and funds is arresting. Anyone with a computer can now access the same information and tools as professional investors.
That's not just theoretical, either. According to a study by the Investment Company Institute, of the millions of households that own shares in mutual funds, "the Internet has become central to many shareholders' management of their finances. About eight in 10 shareholders with Internet access go online for financial purposes, such as to check their bank or investment accounts, obtain investment information, or buy or sell investments."
Shameless Spider-Man reference ahead
With great power, though, comes great responsibility. And data shows that such empowerment sometimes backfires.
As Fool co-founder David Gardner has said time and again, "The market is so short-term." The real-time streaming quotes, daily news stories, frequent analyst upgrades and downgrades, and quarterly earnings reports program investors into a certain mind-set, where minute-to-minute information becomes more significant than it needs to be. Investors, in short, outsmart themselves.
That's a conclusion from the work of professors Brad Barber and Terrance Odean, who studied the investing habits of 60,000-plus individual investors in the 1990s. They found that investors moved in and out of stocks far too frequently, thereby suffocating returns and generating excess tax and trading costs to boot. Put more simply, they concluded that "trading is hazardous to your wealth."
Why, then, do investors trade so frequently? In the words of Barber and Odean, "We believe that these high levels of trading can be at least partly explained by a simple behavioral bias: People are overconfident, and overconfidence leads to too much trading."
See, information breeds confidence. Many investors today -- pros and amateurs alike -- believe that they can know more than their fellow investors. But here's something we pretty much take as gospel these days: If you discovered a "trading signal" on the Internet, hundreds of thousands of other people did, too.
Get out of that mind-set
The recent market nosedive, and the subsequent doom-and-gloom news headlines, have been stressful. We've received a ton of email from folks wondering the same thing: What should our next move be? As we see it, the rules of the game haven't changed -- if you're seeking long-term wealth from the market, live by three rules:
- Buy great companies ...
- at good prices ...
- and be patient.
The first point is paramount. "Buying companies" is much, much different from "trading stocks." It's also a lot easier and a lot more reliable. So if you want to make serious money in stocks, start with great companies.
Easier said than done
What makes a great company? That's the rub. There can be a lot of ways to measure greatness. Adobe Systems (Nasdaq: ADBE ) and Commerce Bancshares (Nasdaq: CBSH ) (parent of Commerce Bank), for example, have high net promoter scores, which measure how well customers like the company. Colgate-Palmolive (NYSE: CL ) and Charles Schwab (Nasdaq: SCHW ) have nearly unmatched brand and marketing savvy in their industries. Network Appliance (Nasdaq: NTAP ) and Qualcomm (Nasdaq: QCOM ) have special corporate cultures and are among Fortune's "100 Best Companies to Work For."
We're not advocating that you go out and buy those specific companies, but they are the kinds of companies you should be buying (not trading!) right now -- and holding for the long term. In fact, two of them -- Adobe and Schwab -- have been recommended in our Motley Fool Stock Advisor investing service.
And that's not surprising. Fool co-founders and Stock Advisor analysts David and Tom Gardner have long track records of discovering great businesses. They believe that they have many of the best long-term holdings racking up returns on their scorecard. Since the service's inception in 2002, their picks are outperforming the S&P 500 by 48 percentage points.
If you are ready to stop trading stocks and start buying great companies, and you'd like a few ideas to get started, click here to see the companies that have made the cut in Stock Advisor. A trial is free for 30 days and gives you full privileges to the service.
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This article was originally published Dec. 8, 2006. It has been updated.
Neither Brian Richards nor Tim Hanson owns shares of any companies mentioned. Adobe and Schwab are Motley Fool Stock Advisor choices. The Fool has a disclosure policy that built this city on rock 'n' roll.