Beat the Market by Fixing This Behavioral Flaw


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Jae Jun

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Daniel made a great point from his 25 investing lessons. It is incredibly difficult to beat the market.

I haven’t beaten the market for 2 years straight now, although I hope to break that trend this year.

The most recommended method is to invest in the index but for people like myself, there’s no fun in that. Profiting and making money is the end goal, but I know that it isn’t the only goal which is why I continue to learn and invest on my own.

One way in which individual investors, myself included, can work to improve is by lowering activity and churn.

Reduce Activity and Lower Churn

In 2010, I had a total of 83 transactions. In 2011 that number dropped to 42 and 2012 YTD it has come down drastically to 13. Only possible because it was an area I identified as needing improvement and consciously worked towards.

I’ve documented my struggles in 2010 and 2011 so I won’t get into all the details, but increased activity was definitely hindering performance.

My brokerage fees are $7.95 per trade.

83 x $7.95 = $659.85 down the drain.

Had I only made 20 trades in 2010, my performance would have improved by $500.

An article I read from AAII last week resounded deeply with what I have been working on this year.

decisions of individual investors who sell a stock and buy a stock, which means that they are not selling it for liquidity; they’re selling it because they believe the stock they sell is inferior to the stock they buy. There is no other reason. Now, when you wait a year, and you look at the value, on average, of the stock that individual investors sell and the stock they buy, then you get a difference of 3.5%, roughly, almost 4%. So that means every action the individual investor takes has negative expected value. On average, they lose, and the more ideas they have, the more they lose. Women do better than men because they churn their accounts less. – AAII

If you’ve been a long time reader, you’ll know that I tend to go through a lot of stocks. I may not write about specific stocks as much but I have a lot of ideas throughout the course of one year which isn’t always a good thing.

I bought RSH before earnings and promptly afterwards it dropped more than 30%. Had this happened in 2010, I would have looked at the bad results and sold it at a loss categorizing it as a mistake even though it is such a small position.

This time around, I’m not jumping to conclusions so quickly. I’m going to wait a little longer to digest and understand the information. There is a fine line between rationalizing and not “jumping to conclusions”, but I am aware of the differences and how I react to each one.

After reading this, what is your activity like? Is this something you can relate to or not?

  • Aku

    Jae – Good post
    my trades last year were about 15. Per trade I pay 2.95 so thats $45
    I have my stocks show up on igoogle finance, a bad thing because it keeps giving you updates every time you hit home button or open a browser.
    However when I see many red numbers then I close the browser or open yahoo or some junk news to read. I passed the emotional stress of seeing my portfolio value drop to 40% because one stock I held was equal to my 50% of portfolio, did nothing. I took the opportunity to buy some more to bring the average down. I stopped comparing my performance with S&P, savings give 0.85% interest and CD = 1.1% for 5 years, if I did nothing then I would earn 0.85% to 1.1
    If I can beat that I am happy 🙂 so far I am beating that with an order of magnitude.
    I have this quote written on my computer – “Even this will not last forever” to keep my emotions under control.

  • Jae,

    Great post. I can relate to this one, big time. This year has marked quite a huge change to my strategy in terms of churn. I’ve made about 10 transactions this year but I haven’t made any since March. This approach has brought much more clarity to my strategy. I think the psychological benefits of lower churn are just as great, or even better, than the tax and fee implications.

    I actually wrote a post on this a while back that relates to this subject: The Awesome Benefits of a Low-Turnover Portfolio – http://www.valuefolio.com/blog/the-awesome-benefits-of-a-low-turnover-portfolio.html

  • umer ashraf

    I have been investing only for last year or so but one thing which i learned quickly in this bussiness is to do thorough research (statistical and comprehensive). Once you are done and you believe (which you could be wrong even after research) market has undervalued it, than you have to hold on to it even though it is declining in value but eventually you will be rewarded if your thesis is right. It might take few days, months or years. Only problem is ROIC. Now at the end you might end up loosing money but atleast you can look back and check your mistakes. However, after only few days or for that matter months doesnt give you real picture and you can’t learn much from it and actually make fall assumptions.

    Currently, I am looking at RIMM. Prem Watsa has been buying shares in the company for a while despite company taking a beating on the street. But he believes it is undervalued and is looking for a turnaround. I will see how it pans out. I have small position in it myself. It is a case study for me.

  • Ya, my personal belief is that deciding when to buy is easy. I don’t have nearly as much trouble backing off and saying, I haven’t done my research on this stock so I won’t buy it till I know more. That being said, after taking a quick hit it’s easy to want to sell the stock. I feel like, treating stocks like businesses, I won’t sell a company unless I think the value of the business has declined or shows signs of future decline. Also, one change I made on review of my performance last year is that now whenever I make an investment I write down my assumptions, I call them my “Pillars” of the investment. So for example, if I’m investing in a net-net, my thesis’ assumption often includes the idea that the net-net won’t burn too much cash. If the net-net burns cash, it breaks the pillar and if enough break the castle falls…It’s my way of figuring out when I should just get out of a position.

  • Aku

    Jae – good post,
    I trade about 15 to 20 a year (buy and sell combined) per trade cost is $2.95 so in a year commission is $45 to $60. I try to avoid selling shares within a year to take the big tax penalty but its can not always be voided.
    I don’t check my performance with S&P, savings and CDs yield 0.85 to 1.1 % year. If my investments are yielding more than that I am happy and so far I am beating the savings number by a order of magnitude.
    One time my portfolio went down 45% I did not panic, stopped looking at the stocks for a while. I put this quote on my monitor frame.
    “Even this will not last forever” this quote helped me many times.

  • Derek

    I am painfully aware of making too many trades and the costs associated with that. When I first started investing three years ago I was like a kid in a candy shop. I was flipping stocks left, right and centre, but usually at a loss. Combine that with the outrageous fees I was paying to the brokerage firm of a major bank (seriously, the amount they were charging should be illegal, it was so high), I lost A LOT of money.

    I tapered my transactions last year by about half.

    This year I’m only at about 20 or so.

    When you really do your research, you can get away from the impulse to grab a “flash in the pan,” which you often wind up jumping in too late and wind up in a downdraft.

    That said, I am moving more towards have a core position and a trading position, especially in these choppy, volatile markets. A number of my stocks have been up 20 or 30 per cent but then slide back to where I started. I didn’t take any profit, so I missed out. Now I’m thinking about selling a third when I realize such a gain.

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