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When It Pays To Be Idle

By Maynard Paton (TMFMayn)
February 2, 2004

"Lethargy bordering on sloth remains the cornerstone of our investment style" -- Warren Buffett

The stock market is one of the few areas where idleness can be a real positive. Buying a group of solid, sound companies -- and simply holding on -- frequently provides better returns than frantic trading activity. Just ask Mr Buffett, any index tracker fan or a high yield portfolio investor.

Indolent investors obviously benefit from a reduction in frictional costs. Cutting out the extra stamp duty, dealing charges and spreads all helps to bolster a portfolio's performance.

Another reason why the 'idle' stock picker tends to do well is that discovering great investment opportunities is hardly a day-to-day event. You see, nobody can be an expert on every listed company. What's more, other investors (save for the odd panic) are loathed to sell down their holdings at give-away prices. Those who believe they can regular trade in and out of 'bargains', therefore, often end up extracating themselves from deservedly cheap shares. Indeed, a study of 66,000 individual trading records by academics Terrance Odean and Brad Barber concluded the most active stock pickers trailed the least active by an average of 5.5% per year. Read more.

And of course, most people are far too confident about their trading abilities anyway. Human behaviour carries a lot of baggage and many of the most ingrained 'caveman' character instincts derive from a sense of self-importance or ego. While bravado may have been a necessity to survive in the Stone Age, over-confidence in the financial markets generally equals over-trading plus under-performance. Read more.


'Portfolio turnover' is the term that measures the share-dealing activity of an investor. Expressed as a percentage, it's calculated by dividing the money raised from selling shares and subsequently reinvested by the portfolio's value. A turnover of 100% indicates the portfolio has essentially sold all of its holdings and reinvested the lot elsewhere.

Calculating an accurate portfolio turnover figure is not straightforward. What happens when a share is sold but the proceeds are not reinvested? What about the portfolio's fluctuating value? New money, reinvesting dividends and accounting for commissions are other complications.

Help is at hand, however, from discussion board regular Gengulphus. He declares: "As a rough measure, I would add up the values of all the buys and sells in the year, divide by two, and then divide by the value of the portfolio."  After noting the many difficulties to arriving at a pinpoint figure, Gengulphus concludes: "I would just do the straightforward rough calculation suggested above and leave out the refinements."

Qualiport trading

The table below reveals the Qualiport's turnover percentage for the last three years. To keep things simple, prior years were not studied as new money was at that time added to the portfolio. Furthermore, the average portfolio value is calculated by using only the start-of-year and end-of-year levels. Dealing commissions and other costs were not included.

Year Average portfolio
Buys plus sells
divided by 2
2001 21,982 10,409 47
2002 20,057 6,394 32
2003 20,341 4,248 21

So, a favourable trend. The average turnover figure for 2001-3 is 33%, which suggests the Qualiport holds a share for an average of three years. But as noted earlier, the portfolio no longer benefits from regular cash injections. Unlike most real-life investors, who would receive additional funds every so often, the Qualiport has to sell to buy when it's fully invested. This situation does increase the portfolio's turnover calculation.

To give some background to the turnover figure, this table lists the holding period for each portfolio share (past and present):

Share                                                Time held since initial investment
Carpetright (LSE: CPR) 2 years 6 months
DFS Furniture (LSE: DFS) 1 year 11 months
Emap (LSE: EMA) 5 years 10 months
Halma (LSE: HLMA) 11 months
Johnston Press (LSE: JPR) 2 years 4 months
London Stock Exchange (LSE: LSE) 1 year 2 months
Dell (Nasdaq: DELL) 2 years
Independent Insurance 2 years 3 months
Lloyds TSB (LSE: LLOY) 3 years 5 months
Marks & Spencer (LSE: MKS) 1 year
Misys (LSE: MSY) 1 year 5 months
MMT Computing 1 year 4 months
PizzaExpress (LSE: PIZ) 4 years
Rentokil Initial (LSE: RTO) 2 years 1 month
Unilever (LSE: ULVR) 1 year 11 months

With the Qualiport now over six years old, a three-year timescale does not sit too comfortably with the 'holding for the long term' strategy. However, the portfolio has made mistakes in the past and -- after some navel-gazing -- cut its losses. Clearing out the laggards -- responsible for much of the selling in recent years -- has in fact bolstered the portfolio's performance significantly. Nevertheless, with the Qualiport now happy with its present stable of companies, the turnover aim for 2004 and beyond is simple: to keep as close to 0% as possible.

More: The Cost Of Portfolio Turnover | Big Investing Mistakes

The author owns shares in Carpetright, DFS Furniture, Halma, Johnston Press and London Stock Exchange.