When Brokers Offer Advice[Fool on the Hill] May 16, 2000

An Investment Opinion

When Brokers Offer Advice

By Matt Richey (TMF Verve)
May 16, 2000

This morning, a Foolish reader kindly informed me of a hilariously wrong story from this past weekend's UK Sunday Times: "Investors Must Sell Shares or Lose Fortune." Get this opening sentence:

"People risk losing thousands of pounds [money] unless they radically alter their investment strategies over the coming months, according to Britain's leading stockbrokers."

The above advice comes from Britain's leading stockbrokers, no less. Those are the individuals who are the U.K.'s very best stock churners, the elite of the commission generators. Objective advice, oh yeah. Hmmm, and I also hear that vampires have offered to oversee the Red Cross blood bank.

And more...

"Experts recommend that investors who hold shares directly should sell when a stock has risen in value by between 20% and 30%. Investors need to be ruthless about selling when they hit their target -- whether this takes hours or years."

The article even goes on to recommend utilizing wireless technology to alert you to second-by-second stock gyrations that might lead to a MUST SELL situation. To this, I offer three words: Rule Breaker Portfolio. Individuals who buy into a philosophy of frequent portfolio turnover and "locking in profits" will never experience a 100-bagger like the Rule Breaker has with America Online (NYSE: AOL) over the past five years.

The Rule Breaker Portfolio is not alone in finding the bulk of its returns in a single well-selected long-term winner. Much of Warren Buffett's multi-decade market-beating track record arose from his 1970s purchase of The Washington Post (NYSE: WPO). The same goes for famed mutual fund manager Peter Lynch with his 1980s super-winner Fannie Mae (NYSE: FNM).

The Sunday Times' argument against the buy-and-hold approach rests entirely upon the market's recent volatility. Supposedly, since some stocks have dropped 50% or more over the past few months, we should believe that buy-and-hold is dead. This argument is so flawed I hardly need to refute it, but here's one historical example to consider:

Flash back to year-end 1986. There's a new company that just entered the public markets a year earlier. It's a revolutionary young company in the risky world of computers, specifically software. The name is Microsoft (Nasdaq: MSFT). If you had bought the stock on December 26, 1986 at $47.75, you would've only needed to hold the stock a month in order to achieve better than a 30% return. It's true that if you'd held throughout 1987, you would've endured several setbacks, one as high as 50% during the famous October crash. But when would it have been smart to sell considering your split-adjusted cost basis today would be only 34 cents?

Today is no different. Revolutionary technologies like biotech and the Internet are laying the foundation for tomorrow's big winners. Long-term owners of today's Rule Breakers and tomorrow's Rule Makers will always endure volatility and temporary setbacks, but that's a small price to pay for the opportunity of reaping returns of 10, 20, or 100 times one's initial investment. In a stock market environment where 10-15% returns are the norm, it only takes one such big winner -- and the fortitude to hold, hold, hold -- to boost your portfolio into the realm of substantial market outperformance.

The rationale supporting the superiority of long-term buy-and-hold (LTB&H) investing rests upon the following three rock-solid principles:

1) Stocks are the best place for your long-term savings -- bar none.

When your time horizon is greater than five years, stocks are your best investment two times out of three. And your odds only increase as you extend your investment horizon. If you know that you won't be touching your savings for two decades, then history is 100% on your side -- stocks have always beaten every other investment over any 20-year period. And these generalizations apply to the stock market as a whole. If you can use your common sense and a little financial analysis to find a focused portfolio of 6-12 world-class companies, then you're likely to do even better than the market's historical average.

2) Frequent trading produces costly frictional expenses.

Over the past 20 years, the average actively managed stock mutual fund has underperformed the S&P 500 by 2% each year on average. Now, take a wild guess as to the estimated performance cost of a mutual fund's fees and turnover expenses? You got it -- 2%, on average. So, even the pros have historically underperformed the market's average return because of the frictional expenses of commissions and mis-timed market timing. As an individual, you can minimize your commissions and capital gains taxes by buying and holding. Every study shows this is the only way to consistently beat the market.

3) The life opportunity costs of trading have a heavy price.

Here's one you don't often hear about. No doubt, time is our most valuable asset. The buy-and-hold approach allows us to spend as little as a few hours per quarter studying stocks, so that the rest of our time can be spent on more valuable pursuits, like getting outside for an afternoon of golf, or a weekend trip to the mountains, or... you get the picture. Life is too short to be consumed with a Quotrek's "beep, beep, beep" buy/sell alerts. Why waste your most valuable asset wringing your hands over investments?

LTB&H always falls into question when the markets get rocky. Fools will ignore the drivel such as the Sunday Times piece, or at least get a good laugh out of it.

Fool on!

Related Link:

  • Rule Breaker Report, 5/8/00: Why "Buy-and-Hold" Must Go