EL SEGUNDO, CA (Nov. 2, 1999) -- One of the first questions a new investor asks when coming to the workshop is, "If these strategies are so great, then how come people haven't been investing in them for years?"
There are many answers to that question. First, personal computers and the Internet played a huge role in making possible the research that identified the strategies and the communication between investors that fueled the ideas. Not all the data to run these screens was available until the mid-1980s, and at that point there was no data available for backtesting so there was no way to know which strategies might work. And it has only been recently that the markets have been truly accessible to the small investor. These are all part of the answer, but sticking with my recent theme of costs, I'd like to talk today about how the reduced cost structure of recent years lets investors do things today we only dreamed about 15 years ago.
As we discussed in my other cost articles, the most obvious cost is the commission. And, boy has the cost of commissions changed. I'm young enough that I never had to trade at a full-service brokerage house, but you don't have to be much older than I am to remember when that was the only game in town. And while most people like myself scoff at the prices full service brokers charge today, those are nothing compared to the prices they charged prior to the introduction of the discount brokers. That's right, back then you could expect to pay well in excess of a $100.00 for many of the trades we make so casually today.
In the '80s the discount broker came into being. However, the discount broker of yesterday was discounted only compared to Mr. Full Service Broker. If memory serves me, in the mid-1980s my discount brokerage firm charged roughly $50 to $60 for trades over $2000.00, and the cost structure was such that the more you spent, the more you paid. I still remember in the early '90s when I first learned about Kennedy-Cabot with their flat $30.00 trades and an even cheaper $25.00 fee if you bought less than 100 shares. I thought commissions couldn't possibly be cheaper.
So imagine implementing some of these strategies, especially the non-annual screens, when round-trip trading costs alone were routinely over 5% for the small investor.
We haven't even talked about our hidden cost yet, the spread. If the cost of the spreads in the monthly screens seemed high to you, well then, today you are probably getting your first hint why doing monthly screens was suicidal until about five years ago.
Until then, an investor looking to buy a small-cap, thinly traded stock like TTN would be lucky if the spread was less than half a point, and if it was on the Nasdaq you could expect to pay three quarters to a full point. I remember selling one of my early winners, Smithfield Food. The ask was 23 and the bid 22. Yes, a full one point spread. It took government intervention and a lawsuit to get the spreads down to the level they are at today. (Don't feel too sorry for the folks who collect the spread. The huge increase in share volume over the last decade has kept them off the streets.)
So if you were investing in a monthly strategy in 1990, it would take almost a 100% annual return just to break even. For quarterlies, it would take about 25%. Therefore, except for annuals, the kinds of strategies we discuss here were simply not possible then.
Luckily for us, the cost structure for stocks has changed and thus strategies that would have never been viable before are very viable today. This combined with the influx of information available cheaply on computers has created an environment that lets the Workshop thrive to the benefit of the individual investors.
Until next time, Fool On!