Tuesday, August 16, 2011

Investing versus Trading .... Stock Market Gyrations

My view is that investing, as opposed to trading, in the shares of quality companies is the really prudent thing to do with our long term patient money.

That said, if we can't hang in there when the market swings wildly from time to time, as it will, we probably shouldn't own stocks at all. Not for trading and not for investing either. That's because we will not achieve good trading results over time. In simple terms, if we aren't able to stomach the ups and downs of the market, we should stay away from the market entirely, since the stomach churning won't be worth the incremental rewards of stocks over bonds. Even worse is buying high and then panicking and selling out at a much lower point.

Hence, the basic idea is straightforward for individual investors; either invest for the long haul or stay away from stocks. Don't be a trader, unless that's what you do for a living, and somebody pays you well to do it.

For individual investors, the rewards associated with owning shares of solid companies for long periods will invariably prove to be the proper course. The unintended but quite predictable, albeit largely unnoticed, consequences of trading frequently, on the other hand, will almost always be the wrong path to take.

As a reminder of this boring but prudent approach, several current articles on investing versus trading are worth your time. In sum, each makes the case for buying and holding shares in good solid companies over long periods of time.

In contrast, they point out that the interests of most financial intermediaries, including brokers and mutual fund managers, are not aligned with those of the individual investor. We're on our own, in other words. But we can help each other along the way, too. It's simply not that hard to learn how to be a good investor, and we can do it in our spare time.

Accordingly, I recommend that you review each referenced article in this present uncertain and volatile time. The Mutual Fund Merry-Go-Round by David Swensen, the highly successful chief investment officer of Yale University, tells us why we need to figure out our own way to successful investing. In that regard, Swensen details how most brokers and actively managed mutual funds don't serve the interests of individual investors.

Short term "performance chasing" by selling losers and buying winners frequently is a common way of losing money or considerably underperforming the market indices over time. By buying high and selling low, which is what happens most often with active traders, the individual investor loses as his broker or mutual fund manager wins. To cut to the chase, the performance of the individual investor is harmed measurably by following the frequent trading herd. Listening to what Swensen has to say is definitely worth the time.

Don't Panic About the Stock Market offers timely advice from another investing pro. He advises us to stay the course, despite today's turbulence, and look to the long term future instead of focusing on the wild and volatile time we're in today. What he says is also sage advice worth hearing.

Finally, How investors can handle the market's turmoil and Be an investor or a trader, but not both advise the long term investor to stay the course, and make a genuine effort to ignore the daily onslaught of market moving emotional news items.

Good companies will perform well over time, and their earnings will be shared with their shareholders. We must never confuse a company's short term operating performance with its stock's daily, weekly, monthly, quarterly or annual gains or losses.

As Warren Buffett puts it, the market in the short term is a voting machine, but in the long term it's a weighing machine. We simply need to know that we own pieces of good solid companies (or as a proxy therefor a low cost passive S&P 500 index fund). We do not own pieces of the stock market, but we invest in companies whose shares are traded on the market. There's a huge difference between the two ways of looking at the same thing.

As individuals we are not qualified full time and professional traders; instead we are long term investors. We're in it for the long haul. Accordingly, we play a different game than the traders, stock brokers and mutual fund salesmen.

We investors know that owning shares of good companies is a long term winning strategy, and we adopt a patient approach. We minimize transaction and other intermediary costs associated with frequent buying and selling, including taxes on gains. And we employ a dollar cost averaging buying technique as well. We like to buy when things are on sale, including stocks of good companies.

That said, if we are going to panic when the market falls rapidly and substantially, which it certainly will from time to time, we should do ourselves a favor and just stay away from stocks entirely.

My considered advice is to focus on the long term picture of investing, and if that means turning off or otherwise tuning out the daily news, by all means turn it off and tune it out.

Thanks. Bob.

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