The Facebook Stock's Story ... Buy and Hold Investing ... Stick with Strong Companies with a Long and Successful Track Record ... Be a Boring Investor and End up a Happy One

There's lots of chatter these days about buy and hold investing being a thing of the past. My view is different, and here is some solid evidence to support it.

The Facebook Flip: Funds Exit Early is revealing for what it says about mutual funds:

"It wasn't supposed to end like this.

Fidelity Investments was an early buyer of Facebook Inc. In the spring of 2011, two dozen of its funds bought more than $200 million worth of the company's private stock. Then, when Facebook went public in May, many of those funds and other Fidelity funds loaded up on publicly traded shares.

Now, many of the giant Boston-based company's fund managers are shrinking their stakes.

Twenty-one Fidelity funds sold more than 1.9 million public Facebook shares combined in June, with 16 of them selling more than a quarter of their stakes in the company, according to investment-research firm Morningstar Inc. Private shares can't be traded until later this year.

It is unclear whether the Fidelity funds made or lost money on the Facebook shares, but the stock has languished below its $38 offering price on May 18. In June, it traded between $25.52 and $33.45; shares hit an all-time low of $20.84 before closing at $20.88 on Wednesday.

The moves represent an about-face for Fidelity, one of the first institutional investors to take a significant stake in Facebook and the country's third-largest mutual-fund company by assets. Fidelity's funds owned the shares for at most six weeks—much shorter than the median holding period of about 22 months for U.S. stock funds, according to Morningstar. . . .

Mutual-fund analysts say it is uncommon for mutual funds to flip shares so quickly.

"Investors expect that what's in the portfolio will be in there for more than a month," said Todd Rosenbluth, a mutual-fund analyst at S&P Capital IQ. "Typically, people who are investing in a mutual fund believe that their fund is investing with a long-term horizon." . . .

Fidelity wasn't the only company with funds that flipped Facebook shares. Turner Investment Partners' Large Growth fund, which has a typical holding period of about seven months, sold 28% of its shares within weeks of buying them. OppenheimerFunds Inc.'s Global Allocation fund in June sold more than 10,000 shares, or 10% of its holdings.

"Some of these funds clearly thought it was going to be a hot deal that they could flip" before the price dropped, said Michael Lipper, president of investment-advisory firm and mutual-fund consultant Lipper Advisory Services. . . ."

 

Now let's look at the broader meaning for individual investors and buy-and-hold investing.

In Picking Facebook Shares, Repeating the Mistakes of the Past says this:

"Since the implosion of the dot-com bubble in 2000, retail investors have been rightfully wary of the stock market. Facebook was going to change it all, bringing the ordinary investor back.

Instead, Facebook was a massacre for retail investors, highlighting yet again why stock picking is a loser’s game. The hype around Facebook was enormous as retail investors salivated at the chance to buy what they hoped would be the next Apple. . . .

The Facebook example is one more confirmation of studies that have shown that, on average, individual investors lose out consistently when they buy and trade individual stocks. They’re better off investing in passive index funds.

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.

This is not surprising. Even mutual fund managers have trouble beating the market. Last year, according to S.& P. Indices, 84 percent of actively managed funds did not beat the Standard & Poor’s index representing that fund’s sector. Going back over five years, 61 percent of funds underperformed. Even so, most mutual funds beat individual investors who try to do it themselves.

If the professionals have such problems, individual investors don’t have a chance. They are not as knowledgeable and not as disciplined. Study after study has found that individual investors have a disposition effect — that is, they tend to sell winners too soon and hold on to the losers by refusing to recognize their failure.

Individual investors are also heavily influenced by their mind-set and their environment.

For one, they are strongly influenced by media reports and buy stocks that are promoted. And, yes, there are studies of Jim Cramer’s show, “Mad Money,” and this effect. One recent study found that the higher the viewership of the show, the bigger the market reaction to stock recommendations. The authors also found that Mr. Cramer’s buy recommendations had more influence than sell recommendations, reflecting people’s desire to bet on winners. But didn’t we know that already from the tech bubble? More than a decade ago, stocks of companies with little or no profits were wildly hyped. It all ended badly, with retail investors losing the most. . . .

The Facebook affair was but a sad repeat.

These inherent flaws put us off on the wrong foot when we pick and trade stocks. We don’t diversify enough, don’t do enough research and tend to sell on emotion rather than logic.

If this weren’t hindrance enough for even the most educated individual investor, the Facebook debacle shows that the market is rapidly changing in ways to make it even harder for individual investors to profit. . . .

Beyond all of these barriers, individual investors are also faced with a stock market that has remained stagnant for the last decade.

So what can be done?

One thing to consider is whether to further educate individual investors on the problems of investing on their own. The studies show that in general, investors are better off in passively managed index funds. But even here, investors tend to defeat themselves. At least one study has found that investors who engage in passive exchange-traded funds eat away the gains in performance by using this as an excuse to trade more. The problem again occurs when investors try to trade on their own. . . .

But the bottom line is that more needs to be done to educate and help individual investors. It should become common knowledge that investing in an individual stock and trading may be fun, but it may also be dangerous to their wealth."

My Take

Invest in strong and highly profitable companies with a long and well established track record. When you buy, you should intend to stay the course, and not to make a quick buck trading. That's the difference between investing and gambling.

Don't get caught up in the emotion of hot stocks, new companies or IPOs.

Owning shares of strong companies is a winner over time as long as we don't get cute or greedy.

Stick with the basics.

Facebook has a whole lot of valuable lessons to teach us individual investors about how not to invest.

Let's learn that lesson vicariously.

Thanks. Bob.