Advantages of Long-Term Focus

"The investor's chief problem—and even his worst enemy—is likely to be himself."
--Benjamin Graham, mentor to Warren Buffett

A recent study of the trading activity and returns earned by nearly 65,000 people led its authors to the conclusion that "trading is hazardous to your wealth." Two finance professors from the University of California at Davis, Brad Barber and Terrance Odean, found that investors who followed a buy and hold strategy fared far better than frequent traders.

Why Trading Hurts Returns
The investors who did the most trading earned a return of just 10.0% after trading costs, while those who traded infrequently earned a return of 17.5%. To understand the difference between the returns, consider that $1,000 grows to $6,700 in 20 years at a 10% annual return; at 17.5% it grows to $25,200. But that's only part of the story. This study didn't take taxes into account. If it had, the active traders' profits would have been further eroded. Any time you sell securities outside a tax-advantaged account, there are tax consequences. And if you've held the securities less than 12 months, any gain will be taxed as ordinary income, rather than at the preferential long-term capital gains rate. In contrast, if you simply hold securities any appreciation is not taxed at all until the eventual sale. The difference in returns between the two groups examined in the study can be attributed to three factors:

• transaction costs, including commissions and the loss on the spread between "bid" and "ask" prices,
  
• being out of the market, at least temporarily, between selling shares and buying others and
  
• selling at the wrong times or selling the wrong stocks. In a separate research paper, Odean found that when investors decide to dump shares, the stocks they purchase generally underperform those they sell.

Applying The Philosophy To Mutual Funds
If you choose to buy shares of a mutual fund rather than individual securities, you may find it worthwhile to pay attention to the turnover rate, or how frequently the fund buys and sells securities. Mutual funds are required to distribute realized gains to their shareholders every year, so you will pay the tax consequences of trading by your fund manager.

Stick With The Plan
It makes sense to carefully weigh a variety of investment options to find the ones that most closely match your own goals, risk tolerance and time frame. But once you've made those choices, financial advisors recommend that you adhere to them. Reacting to swings in the marketplace, or chasing "hot tips" from friends and colleagues is not a recipe for success. Instead, consider making revisions to your portfolio only when changes in your own circumstances dictate it. For instance, you may want to modify your investments if you'll need to start drawing income from them, or if your portfolio needs rebalancing.

By devising an investment plan and sticking to it, you can become an ally—rather than an enemy—to your own prosperity. Contact us for a referral to an investment specialist for help mapping out a strategy.

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