SOURCE: Disciplined Growth Investors
MINNEAPOLIS, MN--(Marketwired - Aug 29, 2013) - You need to set aside the bifocals and replace them with binoculars if you want to give yourself the best possible chance for superior long-term growth in the stock market, claims author Frederick K. Martin of Disciplined Growth Investors.
Investors' short-sighted fixation on the stock market may be misguided, says Martin, but it's perfectly understandable given the influence the big firms on Wall Street wield over the mindset of main stream investors. Brokerage firms are in business to generate transactions and they put considerable marketing muscle into fostering a short-term mentality among the investing public.
In his book, "Benjamin Graham and the Power of Growth Stocks" (McGraw-Hill), Martin makes the case that rather than micro-analyzing a company's current and near-term developments, an investor can get a much better perspective on a stock's prospects by focusing on long-term trends.
Not only have Wall Street firms instilled a short-term mentality in the investing public, they've also infused the same attitude on their own legions of portfolio managers -- to the detriment of the clients they are paid to serve. "Institutions grade their money managers on their performance every three months," writes Martin. "It's a practice that's designed to enforce short-term compliance with a unified investment approach for their money managers, but it ultimately undermines the long-term returns for the client."
Mutual funds and investment management firms closely monitor the quarterly performance of all of their portfolio managers to make sure they're not drifting too far from the market averages. They don't want their portfolio managers wandering off the reservation with a radical investment management approach that could alienate clients.
But by emphasizing quarterly performance, investment firms are forcing their portfolio managers to make buying and selling decisions for the short-term that are not geared to optimal performance over the long-term. Martin believes that most investment companies would do well to dispense with the quarterly reviews.
"There's no magic to three months, no special significance," says Martin. "Three months is meaningless in an investor's lifetime. It's just an arbitrary time frame that the institutions have adopted for their reviews that actually works against the best interests of the clients by stifling the use of intelligent, methodical strategies geared to the long term."
The emphasis on quarterly earnings reports is equally absurd, argues Martin. So is downgrading or unloading a stock just because it misses its quarterly earnings projections by a few cents. Great companies make decisions and implement programs that may take years to materialize. Their earnings in any given three-month period are really irrelevant in the big picture.
But traders on Wall Street play a different game -- they play with their bifocals on. A small disappointment in a company's quarterly report can knock 10 percent off the price of the stock in the blink of an eye. It's times like those that pique the interest of investors with binoculars who have the vision to recognize that the short-sighted reactions by Wall Street can create periodic opportunities to buy great stocks at discount prices.
Furious Trades and Fancy Perks
Portfolio managers have yet another incentive for their short-term trading strategies. Just as retail brokers are adept at persuading their clients to trade actively in the stock market, institutional brokers also exert some sway over the trading practices of the professional money managers they serve.
"They are constantly pitching stock ideas to investment firms like ours," explains Martin, who manages about $3 billion in assets as founder and president of Minneapolis-based Disciplined Growth Investors.
There are some enticing perks in store for money managers who keep the transaction coming. "There is no golf course you can't play, no ballgame or concert you can't attend, no trip you can't take if you're in the good graces of your institutional broker," adds Martin.
"And by all means, you mustn't let them meet your family. There are gifts for the kids, spas for the spouse, and family vacations to the most exotic spots on earth. When you understand the perks that come with an active trading strategy, it's easy to see why some investment managers would prefer an active trading strategy to a long-term buy-and-hold approach."
Would those mutual fund managers with annual turn-over ratios of 100 to 200 percent be as active without the friendly persuasion of their institutional broker? There's no way to be sure. Different money managers prefer different styles and strategies. But investment performance studies have consistently shown that frequent trading has little effect on investment performance. In fact, most studies have shown that investors who trade frequently not only tend to underperform the market averages but also lag the performance of buy-and-hold investors.
If you want to maximize your investment returns, take off the bifocals and use the binoculars to make your analysis. A company's future prospects will have a much bigger impact on the stock's long-term performance than yesterday's quarterly report.