Precision Decisions

Just because you can trade shares frequently doesn't mean that you should.

December 4, 2019 | Insight

Decisions, Decisions

The first thing a student of investing learns is to “buy low and sell high”. In other words, find a stock that you think will increase in price and sell it when it does. This is the conventional wisdom because the stock market is widely seen as a trading facility – a place where buyers and sellers can transact to their mutual advantage. The flaw in this logic is obvious: for every buyer who thinks a stock price will rise, there is a seller who thinks it will not.

Actually, the stock market is better viewed as a way to buy a small piece of a large business that you couldn’t afford to buy all of. It is also a source of liquidity should it be necessary to convert a portion of your wealth into cash for other purposes. Just because you can trade shares frequently doesn’t mean that you should.

Ownership of a business (or a piece thereof) is the best path to accumulate and maintain wealth. A successful business literally creates wealth by producing something having a value greater than the cost to produce it. In essence, all we need to do is identify a successful business, the shares of which can be acquired at a reasonable price, then buy them and enjoy the increase in value of those shares as the company goes about its business and creates wealth. So long as you can foresee the company continuing to be successful there is no need to sell. Of course, finding a good business at a good price is not as easy as it sounds, but with only one decision to make, we can afford to spend the necessary time and effort to get it right.

Contrast this wealth creation attribute of ownership with the perceived benefits of trading. Even if an active trader is successful and sells a stock for a gain, two things now come into play: first, a portion of the gain must be paid in taxes (assuming it’s not in a TFSA or other tax-deferred vehicle) and second, if the after-tax value of the portfolio is to continue to grow, the seller must find another stock in which to invest successfully. All three decisions (original buy decision, sell decision and subsequent buy decision) must be correct for the strategy to be successful. Multiply by the number of stocks in a portfolio and the required number of correct decisions mushrooms. What are the odds that all of those decisions can be made correctly?

We think about selling a position if there is a change in the business that might impair the continuation of wealth creation we have enjoyed or if an even more attractive opportunity is discovered. If our original decision to buy was correct however, it is unlikely we will have to make more decisions anytime soon. Our effort is spent trying to ensure the initial decision is correct and then closely monitoring the companies in the portfolio to ensure that the business attributes supporting that decision continue to exist.

We think that one of the most valuable things we offer to our clients is the patience to resist the siren song of the trader. While it may sometimes seem that we are “sitting on our hands” we think that over time, our approach will continue to earn a solid “high five”.