Why did I find myself at a Swiss website the other day, reading the November 2006 thoughts of a fellow named Arnout van Rijn? Well, I don't really know. But it happened. And it was there that I ran across some fascinating information that I'd like to share with you:
"In 2005, the average holding period for a stock was between nine and 10 months. The average investor that buys a stock today will already have sold his position by this time next year!"
I looked up more data and learned that the average holding period for NYSE-traded stocks has fluctuated a lot over time, but it stayed above three years between roughly 1935 and 1980. It has been in a general decline since then. Is this a big deal? Well, yes, it sort of is.
Signs of a coming crash?
Van Rijn notes that this short average "to my mind cannot be considered much more than short-term speculation." I agree. As he points out, the last time holding periods were this short was in the 1920s bull market. The Crash of 1929 drove out short-term speculators, leaving more long-term investors in the market.
But let's remove emotional thoughts of crashes and examine the issue with more reason. As van Rijn notes, given that most investors believe that stocks should be held for the long term, it's odd that our overall behavior reflects little adherence to that. He calculates that with brokerage commissions, it's not hard for a small investor to spend 1% or more of his portfolio's value on trading costs. (That would be $500 on a $50,000 portfolio, which might be made up of 25 $20 trades, for example.) That's significant, because it essentially reduces your average annual gain by a full percentage point.
The good news
Fortunately, the situation might not be as bad as it appears. As my colleagues Tim Hanson and Brian Richards pointed out in their article "One Stock to Buy Today," half of all U.S. investors trade less than five times a year, and only a tiny fraction call themselves day-traders. So perhaps a good-sized majority of us are indeed trading reasonably and rarely.
Still, it does look like some are overdoing it, and hurting themselves in the process. Take a few minutes to determine which camp you're in. Look over your trading records for the past year. Why did you buy various holdings, and why did you sell? How long, on average, do you hang on to your holdings? Do you sell when a stock meets or exceeds your estimate of its fair value, or when you need the money, or when you no longer have confidence in its prospects? Or do you sell because you found another company that looks slightly more promising or because you just got tired of waiting (a few weeks or months) for the stock to pop?
Do a little math, too, totaling your trading costs for the year and comparing them to your portfolio's value. (If you think you're spending too much per trade, look into finding a better brokerage. Our Broker Center can help, featuring several brokerages with commissions less than $10.)
Back to funds
While you're searching your investing soul for your holding-period habits, do so with your mutual funds, too. That's because the best-performing funds tend to have lower turnover rates in general. And just as individual investors seem overall to be developing itchy trigger fingers, so do mutual fund managers. In a 2005 speech, index fund pioneer John Bogle noted that the average turnover rate for stock funds rose from about 25% in 1950 to more than 110% in 2004.
If you look into the turnover rates of those mutual funds you respect most, with the best performances, odds are you'll find a lot of low turnover rates. Consider Bill Miller's Legg Mason Value Trust (LMVTX) fund, for example, which beat the S&P 500 for 15 years in a row before snapping its streak in 2006. Its recent turnover rate? A mere 13%. With long-term winners like Sprint Nextel
For many investors, if not most, a simple index fund or three may be all that's needed. But if you'd like to try to do even better with some of your money, dig into the world of managed mutual funds, as there are some excellent contenders out there, sporting low fees, low turnover rates, and strong performances.
We'd love to help you find them, too -- so I encourage you to take advantage of a free trial of our Motley Fool Champion Funds newsletter. It has recommended many terrific funds (I've invested in a handful, myself) -- and its recommendations, on average, are beating their respective benchmarks by some 14 percentage points. (With our free trial, you'll get 30 days of full access to all past issues and all fund recommendations.)
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