Investment Strategy

Beware the temptation to trade too much

In a world of saturation level communication and instant data there’s a constant temptation to trade. This is just what the brokers and bankers want, since they make more money that way. In fact, less is more. Most individual investors will do better if they do little most of the time. At certain times – like now – it’s more important than ever.

Some people just can’t help themselves. They can’t help tinkering and meddling with stuff all the time. My upstairs neighbours definitely fall into this bracket.

In the several years that I’ve lurked beneath their floorboards, so to speak, they’ve been engaged in almost constant renovation works. If they don’t live in a gilded palace by now then something underhand must be going on.

What’s more I suspect they’d make very bad investors. Many people are constantly tempted to fiddle with their portfolio. In fact, it’s usually best to do the opposite: namely, as little as possible.

For best results I recommend that you spend lots of time educating yourself, working out the overall strategy, hunting out the best bargains, working out what to avoid and setting up your portfolio. But, once it’s in place, you should occupy yourself very little with trading or changing anything.

A typical stock portfolio should consist of 20 to 30 stocks, or a handful of ETFs (exchange traded funds) and up to 20 stocks. More than that becomes unwieldy to track. Less becomes too risky. If you have, say, 25 stock positions of equal size, then even a company bankruptcy and full loss on that position can only snatch away 4% of the stock portfolio.

For best results, you should aim to buy stocks when they’re cheap and sell them when they’re not. Then repeat…again and again.

Fortunately, markets are inefficient beasts, or easily startled, or prone to fashions and fads. Thus they serve up bargains on a regular basis, for those prepared to look.

But the process of those bargains rising back to where they should be priced – as more investors discover them – usually takes a few years. In my experience, it’s generally between two and five years for a neglected gem to regain the admiration that it deserves. Although it can be quicker or slower.

So let’s say the average holding period for each stock is four years. And let’s also say you’ve got 20 stocks (to keep the numbers simple), built up over a number of years. On average you’d expect to sell five of them each year, being 20 divided by four, and buy five replacements. That’s just 10 trades a year.

Of course there will be a bit more to do than that. Individual positions may get too big, deserving a trim to keep risk in check. Or a stock price might fall further, despite sound business fundamentals, offering an opportunity to buy more at an even lower price.

But, on the whole, if you’re trading more than once a month, on average, you’re probably doing too much.

That said, your trades aren’t likely to be spread evenly over time. In my own case I find activity is necessary in fits and spurts. Sometimes I’ll go for many months without trading anything, and sometimes even years. Then I’ll suddenly make a load of changes at once (after some careful thought).

You should buy loads after markets crash, when pessimism is widespread and bargains are plentiful. Sell a few things from time to time – to stop positions getting too big, or because valuations are now high. Add occasionally when you spot individual bargains that the market offers up. Do a bit of rebalancing once a year, so you stay true to your overall strategy.

Right now I find myself in a relatively quiet time. Bargains are pretty thin on the ground, especially in the US market. I sold quite a few stocks earlier in the year, since I reckoned they’d run their course…or at least most of it. (Recently I noticed that quite a few have fallen hard since I sold.)

Typically, I’d owned those stocks for quite a few years, mostly between five and seven. In most cases I haven’t replaced them yet, and keep the cash instead. Where I have bought into new positions I’ve been highly selective.

Markets are mostly high. There’s no rush. But I’m developing a wish list of potential targets to buy. That cash makes next to nothing now, but it will make up for it when deployed in future.

But, apparently, I’m in a minority. This chart I came across shows cash allocations of US investors at all time lows. This was across individual investors, mutual fund managers and institutional investors such as pension fund managers. See the blue line.

According to this, US investors are holding even less cash than during the late ‘90s tech bubble and the mid-2000s housing / hedge fund / private equity / general leverage boom.

That makes me even more comfortable that I’m doing the right thing by reducing exposure to the stock markets and going against the crowd. That, and the worryingly high, indeed record amount of margin debt that US stock speculators have taken on (see here for more).

Not only that, but a record proportion of American investors are anticipating further stock market gains, as shown in this next chart.

When it comes to investing, it always pays to be patient and do little. Right now – with the huge US stock market flying high but short on fuel – this looks even more important than usual.

Don’t worry about “FOMO”, the fear of missing out. Instead you should worry much more about the risk of being drawn in.

[If you missed it, you’ll find my full, recently updated recommendations on how to position your portfolio here.]

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.