Fidelity’s Best Investors Are Dead

A news item that has gotten a lot of attention recently concerned an internal performance review of Fidelity accounts to determine which type of investors received the best returns between 2003 and 2013. The customer account audit revealed that the best investors were either dead or inactive—the people who switched jobs and “forgot” about an old 401(k) leaving the current options in place, or the people who died and the assets were frozen while the estate handled the assets. The next best performers were those with energy, healthcare, and small-cap value portfolios.

My speculation on why dead people beat everyone else is that there is no temptation to employ recency bias and sell a stock simply because the price of the company went down or they assume that the recent bad economic conditions will continue perpetually into the future. Take something like BHP Billiton, one of the jewel companies with focused operations in Australia and South America. This is the premier to own for production of diamonds, oil, copper, zinc, manganese, silver, natural gas, coal, and iron ore. It has delivered 12% annual returns over the past quarter of a century, with a big chunk of those returns coming from the dividend payment.

Yet, over the past year, the price of the stock has come down from the $70s to the $40s. Many people have written about selling the stock. I found that move unwise because it is a classic example of selling low. Even with the price of commodities lower than usual, BHP Billiton is still expected to make $8.9 billion in profits this year. It’s still one of the fifty most profitable companies in the world even right now, and yet, people are getting mad that a cyclical commodities stock is having a cyclical trading pattern.

Instead, people should be taking advantage of the lower share price in the $40s and reinvest the $2.48 annual dividend that gets paid in two installments—you get $1.24 in March, and $1.24 in December. Even if the dividend froze for the next ten years, you would collect $24.80 in cumulative dividend payments from a $45 per share investment (or $43 per share if you are an American investor and choose to purchase the BBL listing.) Even without assuming dividend growth or adding the turbo-charged effect of reinvested dividends, you are still on pace to collect half your initial investment in cash profits from the business alone over the next decade.

But the data indicates, over and over again, that people don’t do this. The DALBAR Institute 2012 study showed that investors receive three percentage points less per year than the S&P 500 generated from 1992 to 2012, and the average holding period for a typical investor is six months. Six Months!! When you hold a stock for less than a year, you are not using the stock market to acquire business ownership positions and participate in the growth of that business. Instead, you are just guessing at short-term news and expectations, and your returns are based on how other people react to that news information. In aggregate, that kind of attitude gets you three percentage points less per year than you’d get from doing nothing at all beyond making the initial investment in the index fund of The S&P 500.

Another part of the problem is the spotlight effect in which the media highlights the failures of Enron, Worldcom, and Lehman Brothers to suggest that large companies are unsafe. But those data points don’t offer a proper basis to form conclusions. Someone I knew in high school runs an emerging website on Free Range Parenting, where you teach kids important lessons at an early age by letting them perform basic tasks by themselves like playing at the park, running to a grocery store, and so on.

The best statistic she has in her favor is that kidnapping is 75% less likely today than in 1960—pointing out that children are safer today than they were in the era when kids actually spent their days unchaperoned. And yet, the conventional attitude today is that those parents are reckless and irresponsible for letting their ten-year olds out of sight so much. It’s a product of a spotlight effect in which childhood kidnappings and other tragedies got top billing on TV, blogs, and Twitter. Someone in Vero Beach, Florida wouldn’t know about a kidnapping in Missoula thirty years ago. Now, you will. And that creates an exaggerated sense of frequency.

The investment equivalent of this is that S&P 500 companies are extraordinarily unlikely to go bankrupt. If you buy a stock in the S&P 500 today, there is only a 1.5% chance it will go bankrupt within the next five years. Now, stocks get removed from the S&P 500 Index every year. Some people act as if removal from the S&P 500 Index is proof that a company’s shareholders got wiped out or the company entered a permanent decay. They ignore Jeremy Siegel’s research that indicates companies removed from the S&P 500 Index actually outperform the companies that replace them in the index (Siegel pointed out that buying the original S&P 500 and holding it forever would give you an extra 1.5% per year over actually owning an S&P 500 index fund that incorporates the new changes because the depressed valuations of companies leaving the S&P 500 provide a value basis for outperformance going forward.)

You’ll see people say things like, “Why would anyone buy and hold stocks when General Electric is the only company left in the Dow Jones?” That logic suggests that the other 11 of the original 12 Dow components went bankrupt. It ignores that American Cotton Oil are now Unilever shareholders. It ignores that American Tobacco became Fortune Brands and all the home security and Jim Beam Whiskey spinoffs. It ignores that the Distilling & Cattle Feeding Company was paid a 50% premium when it got bought out by private investors. It ignores that the original Chicago Gas shareholders are now Wisconsin Energy shareholders. It ignores that Laclede Gas may have left the Dow, but it still a profitable utility in Missouri generating 10.5% annual long-term returns with dividends reinvested. It ignores that United States Rubber shareholders became Michelin shareholders. It ignores that National Lead shareholders are now Halliburton shareholders. It ignores that the North American Company now exists as Pacific Gas & Electric stock. It ignores that Tennessee, Coal, and Gas exists today as U.S. Steel stock.

U.S. Leather shareholders, however, did get wiped out when they turned into Keta Gas & Oil stock. Accounting fraud and then theft doomed the asset base after a Wall Street financial engineer named Lowell Birell raided it. So if you purchased the Original Dow 12, you’d still have profitable stock in 11 out of the 12 original companies. And the only failure was the result of managerial incompetence, rather than a deteriorating product line that led to bankruptcy.

With all that in mind, it’s no wonder that dead investors are Fidelity’s best. When you’re dead, you can’t sell low. Some people seem to think that owning a stock is supposed to be a relentless ride up, with constantly growing profits, dividends, and rising share prices. The only company I’ve ever studied closely that came near fitting that billing has been Visa. But even Visa saw its price decline during the financial crisis and come down a bit last summer. I think the analysis of in favor of holding through thick and thin is so persuasive that I don’t even advocate selling after a dividend cut. There are too many examples (oil companies in particular) of delivering strong outperformance following a dividend cut because that usually signals a low for the stock price. If BP paid out $0.30 per share next quarter instead of $0.60, I wouldn’t advocate selling the stock because the $170 billion reserves and $7 billion per year profit engine would remain intact.

Sometimes, people think they can wait for the start of good news before buying a stock. It just doesn’t work that way. BHP Billiton fell from $96 to $33 per share between 2008 and 2009. Earnings got higher in the first two quarters of 2010, and suddenly, the price of the stock was back up to $93 per share again. The dead or inactive investor reinvested the $1.64 dividends when prices were low in 2009, and then the account captured the gains when the price went back up (but also the reinvested shares purchased in the $30s got carried up to a $90 valuation as well.) This same story that has played out with BHP, and other companies in the energy sector, is playing out before our very eyes again. And some people are selling.

Unfortunately, Fidelity did not provide many details offering us explanations for why dead and inactive accounts performed best. So people like me are left to speculate. And my theory is that people are too quick to apply recency biases and see falling stock prices as a permanent destruction of wealth rather than an opportunity to purchase more. The funny thing is, it’s the same companies doing it, too. You can read Siegel’s book about how reinvesting Chevron dividends during falls in prices leads to high annual income over the decades. And yet, forums today are filled with people selling Chevron stock because the price fell from $135 to $102 and the dividend takes up most of current profits. It’s sad, because during the next uptick in the energy cycle, these same people will be kicking themselves for selling the stock when it was cheaper.

My advice? Practice diversification and don’t micro-manage. If BHP Billiton or Chevron is 30% of your total wealth, you can get emotionally swept up in the share price fluctuations. If Chevron is 4% of your portfolio, you can deal with fluctuations a lot better because even a 50% decline in the price of the stock would only reduce your net worth by 2%. If the rest of your portfolio is also declining substantially in price, then it probably means investors are acting emotionally rather than in response to company-specific fundamentals. That, in itself, can be an indicator that it is a time to buy more. You want your best investing days to be while you are alive. You can cover a lot of ground towards ensuring that by putting in place very strong presumptions that stocks you buy should never be sold. If a thirty-year old bought 30 stocks and held them until his death at age 90, he should statistically only experience four bankruptcies while each of the other 26 stocks should increase wealth 349 fold, assuming they perform like a typical S&P 500 stock did over the past sixty years.

Originally posted 2015-05-26 16:35:57.

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