Do you look at your total trading cost at the end of each year?

I make a point of looking at my total expenses each year at the same time as I review my past years activities and calculate my returns.

Each year I was astounded at the amount I spent just on buying and selling securities in spite of me paying on average only 0,30% per transaction.

About two years ago I took a conscious decision to trade less as I realised that trading cost me at least 0,5% of performance each year and that a lot of investments increased in price, sometimes substantially so, after I had sold them.

My idea that less transactions would equal better performance was confirmed after I read the September 2008 article by James Montier called Going global: Value investing without boundaries

(I could unfortunately not find it on the internet but it is included in James? excellent book Value Investing Tools and Techniques for Intelligent Investment)

In the article James found that being patient definitely pays off when you use a value investing strategy.

When testing a strategy of buying the most undervalued companies worldwide James found that the value strategy outperformed the market by around 7% in the first year. However if you held on to your investment for another 12 months, an additional 6% was added to your return.

And it gets even better. In the third year an amazing 12% outperformance of the market was recorded, followed by another 8% in the fourth year.

So trading less and being patient works.

Not just because you spend less on trading expenses but also because value investing strategies outperform the market over long periods of time.

This has been a rather long winded introduction for a guest post written by Tim Price Director of Investment at PFP Wealth Management in London.

Past articles by Tim I have shared with readers are:

Printing money – A warning from history

A case for gold

Indecent Haste

Happy New Fear


Now for Tim’s article


?At one point, two former employees say, Goldman’s top management was demanding hourly profit and loss statements from certain teams [at Goldman Sachs Asset Management]..?
– Richard Teitelbaum, Bloomberg News.

The watched pot does not boil. The financial equivalent of this old saw, and one of our personal favourites, which we make no apology for repeating here, is Nassim Nicholas Taleb’s fictional retired dentist.

This hypothetical investor is guaranteed to earn 15% per annum from his portfolio with an associated volatility of 10%. These statistics are not open to dispute. But if our investor friend monitors his portfolio in real time, however, the random price oscillations of his portfolio are likely to trigger extreme anxiety.

Depending on the frequency with which he observes his portfolio, our dentist will experience varying degrees of heartache and distress. The frequency of portfolio observation versus probability of a pleasurable outcome for our imaginary investor is shown below:

Timescale ? frequency of portfolio monitoring Probability of favourable outcome (joy)
1 second 50.02%
1 minute 50.17%
1 hour 51.30%
1 day 54.00%
1 month 67%
1 quarter 77%
1 year 93%
(Source: “Fooled by Randomness?, by Nassim Nicholas Taleb)

The message is clear. Too much observation can be bad for you. If Taleb’s dentist simply restricts the frequency with which he checks his portfolio ? a fundamentally sound portfolio ? he will boost his chances of incurring a positive emotional outcome from his monitoring.

Note that nothing changes about the composition of his portfolio ? only the frequency with which he checks it. Investors determined to watch the pot may end up being scalded. There are other reasons to be wary of a focus on the short term.

Jim Leitner of Falcon Management once said:

?If all investors allocate money to a one-month time frame, by definition there are going to be fewer opportunities there.. there’s just too much competition over short-term trading, which is a timing driven business. With timing, sometimes you?re going to be right and sometimes you?re going to be wrong, but it’s not going to be consistent over time.. Meanwhile, the longer-term opportunities still exist because there hasn?t been that much money allocated with multi-year lockups.. That’s not happening yet and probably won?t because investors are way too nervous and shortsighted.?

We draw an additional distinction between the business of trading and the business of investing.

Trading, an activity we try and avoid, for reasons of psychological disinclination and cost, is inherently a short-term activity, not unrelated to speculation. Investing, on the other hand, we regard as a longer term commitment of capital to high conviction themes which we expect to result in a meaningful positive return. Ben Graham nicely discriminated between the two styles in “Security Analysis?:

?An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.?

The crowning injustice of our age is that the monetary authorities, as a by-product of the bailout of the banking system, have effectively demolished cash deposits and badly manipulated the price of government debt, and have therefore forced investors to take on unnaturally high risk simply to keep their heads above the water of inflation.

The exquisite challenge of our age is that we are drowning in information and cultural impulses to (over-)trade.

The Internet is simultaneously a trove of wonders and a cesspit of misguidance.

So it may be that the biggest threat to portfolio performance this year will not be market-led but purely psychological: will we be able to hold our nerve in the face of perhaps vicious short term price volatility?

Jesse Livermore was one of the most outstandingly successful traders of the early 20th Century, immortalised in Edwin Lefebvre’s “Reminiscences of a Stock Operator?.

On the few occasions when he lost money, it was invariably because he chose to override his own rules.

He said many insightful things about the psychology of successful investing, but perhaps his most pertinent observation was the following:

?After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It always was my sitting… The big money is made by the sittin? and the waitin?, not the thinking.?

Tim Price

Director of Investment
PFP Wealth Management
Email: [email protected]
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