Stop renting stocks, start owning them

Whereas home renters pay significant sums month after month with little to show for it, homeowners are building equity in something with lasting value. (Of course, in some situations, renting does make sense, such as if you’re not going to stay in one place very long and the real estate market is overpriced.)

It’s also good to stop renting and start owning when it comes to the stock market. How can you rent stocks? Well, by buying and selling them rapidly and by not holding them very long. Such behavior is speculation, not investing. You’re betting on the direction in which a stock will soon move, when it’s impossible to consistently know what stocks will do in the short run.

A share of stock represents a real chunk of a real company. If you’re a shareholder, you’re a part owner of the firm. Owners tend to do well when they focus on the long-term success of their company.

Here’s some evidence. Two finance professors, Terrance Odean and Brad Barber, studied the trading records of more than 66,000 individual investor accounts from 1991 to 1996, sorting them into five groups based upon trading frequency. They found that the least active group averaged just 1.44 percent turnover per year. This means that if the average investor in this group held 15 stocks, one stock would be replaced from the portfolio roughly every five years. The highest turnover group averaged 283 percent annual turnover, meaning that these investors swapped out their entire portfolios almost three times annually.

Odean and Barber found that the most active group trailed the least active group in performance by an average of more than 5 percent points per year. And this doesn’t even consider the effect of taxes, which were surely significant. (Short-term gains are taxed at ordinary income tax rates, which can top 30 percent, while gains from stocks held a year or more are generally taxed at 5 percent or 15 percent.)

Ask the Fool

Q: If I have a big loss from a stock sale this year, can I deduct it from my income? — T.H., Santa Rosa, Calif.

A: If you have a net loss after offsetting any capital gains with any losses, you can deduct the amount of the loss from your income — up to $3,000 per year. If your loss exceeds $3,000, you can carry over the remainder to the following year.

If you’re in the 25 percent bracket and you deduct $3,000 from your income, you’re excluding that amount from taxation. So you save 25 percent of $3,000, or $750.

My dumbest investment

Boston Chicken (later, Boston Market) was the first stock I ever bought. You could argue that buying this before they went bankrupt was a boneheaded move, but I took it one step further. By the time I decided to invest, Boston Chicken had already gone bankrupt. Under the “Boston Chicken is tasty, so once it reorganizes, the stock is bound to go up” school of thought, I bought about $200 worth at around 70 cents per share. Unfortunately, since I did zero research, I was not aware that the stock was of a type that would go completely out of existence once reorganization was complete. Once I found this out I sold. My proceeds totaled about $24, of which $19.99 went to my broker. At least I didn’t lose much, and I learned a lesson.

Brett, Austin, Texas

The Fool Responds: Many people are enticed by seemingly low stock prices, not realizing that they can get much lower. McDonald’s eventually bought the Boston Market chain.