Sell Stocks Slowly
The more you trade, the less you earn because you pay commissions and taxes on your gains.
Let me start by saying that I’m sorry about Schnitzer Steel (symbol SCHN). Here I am supposed to be providing an example of wise stock selection and instead I get tripped up by a bad case of unwarranted optimism. I bought shares of the Oregon-based metals company earlier this year after concluding that a sturdy economic recovery was under way. That convinced me that Americans would trade in their junkers for new cars in droves, creating a wealth of recyclable material for Schnitzer to process and resell into fast-growing emerging markets. Wrong on all counts. The stock, at $31, is down 31%.
I’m also regretful about Corning (GLW), one of the first purchases for my experimental (though real) “Practical Investing” portfolio. I bought shares of Corning after becoming enamored with its Gorilla Glass product—the tough, light surface that may well encase your smart phone. I watched A Day Made of Glass, a video produced by Corning, with stars in my eyes, thinking that the company was so cutting-edge that investors would reward its stock with a higher price-earnings ratio and, by extension, a higher share price. Corning’s P/E has indeed expanded, but only because the company’s earnings have fallen even more sharply than the stock price.
Trade Less, Earn More
As long as I’m engaging in mea culpas, I should mention that among the 19 stocks I’ve bought, three others are in the red (results are through September 7). But my confessions are more than an exercise in humility. Now that my portfolio is nearing its one-year anniversary, I will allow myself to consider selling some of the losers, as well as winners that I believe are unlikely to repeat their success. I’m mainly looking at what I did wrong in hopes that I don’t repeat my mistakes. (We’ll do a full accounting next month at the portfolio’s one-year anniversary. In the meantime, you can see the entire package.)
Why have I waited this long to sell? It comes down to research I learned about a decade ago when I had the good fortune to hear Terrance Odean, now a finance professor at the University of California at Berkeley, present a paper titled Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment.
I was struck by the paper’s uncommon good sense. The main point was that the more you trade, the less you earn. That’s because you must pay commissions and taxes on your gains, and then you have to find a new investment that performs better than the one you sold. That’s hard to do. In fact, Odean and his research partner, Brad Barber, found that men, who typically trade more than women, earned an average of 2.65 percentage points less each year than they would by simply leaving their investments alone.
Consider the impact of such a penalty. Suppose you invest $200,000 (as I have in our “Practical Investing” portfolio) and earn 8% a year over 15 years. At the end of that period, you’ll have $691,611. If you earned only 5.35% a year (reflecting the cost of the trading penalty), you’d have only $454,372 after 15 years. The difference is an astounding $237,239—more than the amount you originally invested. Trading costs have come down since the study was conducted. Even so, the numbers provide a powerful incentive to exhibit restraint when trading stocks.
After hearing Odean, I vowed I would never sell a stock within a year after I purchased it. Once the year was up, I would reevaluate all of my stocks, asking the same basic question for each: Given current share prices and prospects for the underlying companies, would I buy today? This philosophy means that I will soon take a serious look at the first three stocks I bought for my portfolio. They are Corning, which, at $13, has lost 8%; Intel (INTC, $24), up 9%; and Spirit Airlines (SAVE, $20), up 41%.