The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [64]
No yield could ever be high enough to compensate an investor for risking that kind of explosion. The WorldCom bonds did produce fat yields of up to 8% for a few months. Then, as Graham would have predicted, the yield suddenly offered no shelter:
WorldCom filed bankruptcy in July 2002.
WorldCom admitted in August 2002 that it had overstated its earnings by more than $7 billion.3
WorldCom’s bonds defaulted when the company could no longer cover their interest charges; the bonds lost more than 80% of their original value.
The Vodka-and-Burrito Portfolio
Graham considered foreign bonds no better a bet than junk bonds.3Today, however, one variety of foreign bond may have some appeal for investors who can withstand plenty of risk. Roughly a dozen mutual funds specialize in bonds issued in emerging-market nations (or what used to be called “Third World countries”) like Brazil, Mexico, Nigeria, Russia, and Venezuela. No sane investor would put more than 10% of a total bond portfolio in spicy holdings like these. But emerging-markets bond funds seldom move in synch with the U.S. stock market, so they are one of the rare investments that are unlikely to drop merely because the Dow is down. That can give you a small corner of comfort in your portfolio just when you may need it most.4
Dying a Trader’s Death
As we’ve already seen in Chapter 1, day trading—holding stocks for a few hours at a time—is one of the best weapons ever invented for committing financial suicide. Some of your trades might make money, most of your trades will lose money, but your broker will always make money.
And your own eagerness to buy or sell a stock can lower your return. Someone who is desperate to buy a stock can easily end up having to bid 10 cents higher than the most recent share price before any sellers will be willing to part with it. That extra cost, called “market impact,” never shows up on your brokerage statement, but it’s real. If you’re overeager to buy 1,000 shares of a stock and you drive its price up by just five cents, you’ve just cost yourself an invisible but very real $50. On the flip side, when panicky investors are frantic to sell a stock and they dump it for less than the most recent price, market impact hits home again.
The costs of trading wear away your returns like so many swipes of sandpaper. Buying or selling a hot little stock can cost 2% to 4% (or 4% to 8% for a “round-trip” buy-and-sell transaction).5 If you put $1,000 into a stock, your trading costs could eat up roughly $40 before you even get started. Sell the stock, and you could fork over another 4% in trading expenses.
Oh, yes—there’s one other thing. When you trade instead of invest, you turn long-term gains (taxed at a maximum capital-gains rate of 20%) into ordinary income (taxed at a maximum rate of 38.6%).
Add it all up, and a stock trader needs to gain at least 10% just to break even on buying and selling a stock.6 Anyone can do that once, by luck alone. To do it often enough to justify the obsessive attention it requires—plus the nightmarish stress it generates—is impossible.
Thousands of people have tried, and the evidence is clear: The more you trade, the less you keep.
Finance professors Brad Barber and Terrance Odean of the University of California examined the trading records of more than 66,000 customers of a major discount brokerage firm. From 1991 through 1996, these clients made more than 1.9 million trades. Before the costs of trading sandpapered away at their returns, the people in the study actually outperformed the market by an average of at least half a percentage point per year. But after trading costs,