Wednesday, August 1, 2012

Active Management Does Not Mean Active Trading

If the job has been correctly done when a common stock is purchased, the time to sell is - almost never.

-Philip Fisher, writing in his book "Common Stocks and Uncommon Profits"

The New York Times this morning carried a long piece about individual investors and the stock market.

The author of the article - a professor at Ohio State University - noted that one of the reasons that investors struggle to make money in the stock market is overtrading.

The best investors, in my opinion, tend to take a very long term time horizon when making investments.  True, there are stories of hedge fund managers like Steve Cohen at SAC Capital who are able to make huge sums of money by rapid-fire trading, but these tend to be relatively rare.

Warren Buffett was famously influenced by two investors:  Benjamin Graham, who was his professor at Columbia University, and Phil Fisher, who had one of the best records as a growth stock investor in the 1960's and 1970's.

The quote above has been a mantra that investors like Buffett have lived by for many years, and it is worth reminding ourselves that active management does not necessarily mean active trading.

Here's a quote from the article:

Professors Brad M. Barber and Terrance Odean recently released a paper surveying the evidence. Studies of individual investor trading found that "many investors earn poor returns even before costs." These investors trade badly and tend to lose more money than they would using a simple buy-and-hold strategy in passive funds that match indexes like the Standard & Poor's 500-stock index.
How big is the loss? The same authors in another study of 65,000 investors found that the 20 percent who traded most actively earned 7 percentage points a year less than the buy-and-hold investors, the 20 percent who traded least actively. For the individual investor, that can add up to hundreds of thousands of dollars over a lifetime.