Monday, March 23, 2015

Brokerage fees & the art of delaying activity

“We don't get paid for activity, just for being right. As to how long we'll wait, we'll wait indefinitely.”
- Warren Buffet

Brokerage fees sound like a pittance when you are trading, but if you trade too often then you end up hitting your returns. If the brokerage fee is 0.3% (including trading taxes assuming you're trading on Dalal Street) you end up giving up a good 0.6% if you turn over 100% of your portfolio and 1.2% if you turn over 200%. Now your broker wants you trade as often as possible so you will keep getting calls to trade out of what you bought last month and trade into the new fad. But does that really enhance return?

Brokerage fee is not the only reason to delay activity. There is also a big psychological angle to it. It is very tempting to trade. It makes you feel you’re doing something to enhance your riches. In the process you might end up making some silly decisions. There are always opportunities in the markets and yes Buffet has said that he was running small amounts of money as a portfolio manager he would be fully invested at most times but that does not mean opportunity is everywhere you look. Finding a good low risk high return trade takes lots of work and lots of companies analysed and rejected by an astute portfolio manager. This process of rejection can be very painful and I sometimes get very frustrated with it. You start to imagine that this is all a waste of time. But the truth is that the markets are truly a place where wealth gets transferred from the impatient to the patient.

The hold for a minimum period (1 to 2 years) always motivates me to think long and hard about what I am going to do with my portfolio management strategy. It also instills a fear in me of losing money and watching it melt away as I repent my recklessness. This typically makes me fall back in line. Just to settle the debate ideally your annual portfolio turnover should be no more than 25% and over time once you pick some long run compounders should fall to 15%.