Rule Maker Portfolio
The Quaint Notion of Trading

By Matt Richey (TMF Verve)

MILWAUKEE, WI (Oct. 1, 1999) -- Ahh, October -- my favorite month of the year. Cool weather, college football, the golden hues of autumn... oh and don't forget: It's time to begin wringing your hands over the possibility of a major stock market correction. The Legend of Sleepy Hollow may no longer raise the hair on the back of your neck, but the horror tales of October '29 and October '87 will forever lurk in the back of investors' minds.

The rocky markets of the past two Octobers have only served to heighten the tension that surrounds this otherwise beautiful month. In 1997, the Asian crisis caused a momentary panic. And then last year, the implosion of Long Term (yeah, right) Capital Management nearly brought the financial world to its knees.

It's during this turbulent season that investors sometimes begin to doubt whether the buy-and-hold approach is really best. Yesterday, I saw the following quote on TheStreet.com:

"When we think of quaint notions of the 20th century, one of them will be the notion of the buy-and-hold investor."

- James Cramer, September 30, 1999

For those unacquainted, James Cramer is a hedge fund manager with an itchy trigger finger when it comes to stocks. As a performance manager, he's under pressure to put up strong returns quarter after quarter, without exception. To his credit, Cramer has a market-beating track record over the past decade. But nevertheless, his attack on the buy-and-hold approach is, ahem, wrong.

Here are three reasons the buy-and-hold approach is the runaway winner for individual investors:

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 a 6-12 world-class companies, then you're likely to do even better than the market's historical average.

2) The frictional expenses of trading.

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) Life opportunity costs.

Here's one you don't often hear about. No doubt, our 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. Why waste your most valuable time wringing your hands over investments?

Well, that's it for today. It's been a busy week here in Rule Maker Land, as your managers seek to decide the fate of this month's $500 contribution to the portfolio. On Monday, we'll announce our pick. Tom will make the call this month from among the four cases made this week. See the links below to go back and read the arguments in the Maker archives.

Have a great weekend, and Fool On!