Donnerstag, 12. August 2010

Buy and Holding Investing: How a Coffee Can can Make You Rich

In 1984 Richard Kirby wrote an article in the Journal of Portfolio Management called “The Coffee Can Portfolio”. The article contains valuable lessons that can make us all better investors. It centers around an incident that happened after one of his advisory clients died.

“I had worked with the client for about ten years, when her husband suddenly died. She inherited his estate and called us to say that she would be adding his securities to the portfolio under our management. When we received the list of assets, I was amused to find that he had secretly been piggy-backing our recommendations for his wife’s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it.

Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.” (1)

What lessons can be learned from this little story?

1. Buy and hold works. Unlike a lot of market theories that have no foundation in reason or fact, buy and hold investing works because, as Keynes identified many years ago, corporations do not as a rule pay out all their earnings in dividends or share repurchases. A material part of earnings is reinvested in the business so that over time there is a compounding effect, much the same as happens in a saving account if you reinvest the interest. In a good business, i.e. one that is able to reinvest capital at a high rate of return over a long period of time, the results can be dramatic, as seen in the coffee can portfolio.

2. Generating wealth in the stock market takes patience. The widow was fortunate that she was not in a position to check the quotations of her holdings on a daily or weekly basis. She may have been frightened out of some great investments if she had seen the quotational prices decline or if she had read a newspaper story about a setback with one of her companies.

3. You don’t need to bat a thousand to make a lot of money in the stock market. The story shows that a few big winners can make an investor wealthy.

4. It is folly to attempt to beat the market (or any other benchmark), or to expect your money manager to do so, in every period, i.e. month, quarter, year, etc. The reason is that in the short and medium term stock market prices are driven in large part by psychology and chance. In the long-term, however, it is the underlying economic performance of the business that will determine whether an investment delivers satisfactory results. That’s why it is rational to follow an investment process and philosophy that is businesslike as opposed to playing a dressed up version of musical chairs.

5. Long-term investing greatly reduces taxes and transaction costs. In a world where investors would be wise to moderate their expectations about the returns that equities can deliver, it makes more sense than ever to look at strategies that minimize these costs. Poorly served and poorly informed investors can end up paying 20-30% (or more) of their total return in taxes and fees.

6. If the widow could get this kind of result from a portfolio that was put together somewhat haphazardly, perhaps you can do even better by carefully selecting a portfolio of the best companies available. My investing blueprint was created precisely to provide a framework for doing just that.

7. Reflecting on the coffee can portfolio, James Montier had the following to say in an interview with Migeul Barbosa of Simolean Sense. “It appears as if investors have a chronic case of attention deficit hyperactivity disorder. The average holding period for a stock on the New York Stock Exchange is just 6 months! This has nothing to do with investment, and everything to do with speculation. Having a longer time horizon than these speculators appears to be one of the most enduring edges an investor can possess.” [emphasis added]

This approach will not be adopted by Wall Street any time soon. If you want to invest this way, you’re largely on your own. It is too simple and would seriously threaten the current way Wall Street is compensated.

The Journal of Portfolio Management, Vol. 10, No. 1, Fall 1984, 76-79. New York, New York: Institutional Investor Inc.

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