The Reason You Buy Bad Stocks: Good Stories

Posted on June 16, 2017 at 12:21 PM PST by

Not that many years ago, stock brokers could make a pretty good living just getting their clients to buy individual stocks. Just sell the story and get paid.

Commissions on trades averaged nearly $50 in the 1970s and into the 1980s. Adjusted for inflation, that’s over $200 just for doing a few minutes work executing the trade for the customer.

Naturally, brokers loved doing this. What they needed most to make the sale was a good story. A whole class of investments became known as “story stocks,” shares that had a flashy CEO, an interesting market trend, some kind of hook.

buy bad stocks

The ultimate story stock was one that anybody could understand. Apple Computer, Starbucks Coffee, Nike athletic gear. If your client used the product or even understood what it was, the sale was half-made.

Conversely, it would be very hard to sell a boring stock. Railroads fell out of fashion. Newspapers too. Imagine trying to convince a 30-year-old with money to invest to buy a media company that still throws newsprint onto people’s driveways.

Except that newspapers and railroads were very much the focus of iconic billionaire investor Warren Buffett in recent years. And so they, too, become story stocks. If Buffett was in, why not you, too? The story was the other investors, not the company.

Yet today commissions are nearly nothing, down to under $5. Many exchange-traded funds can be bought and sold at no cost.

Likewise, if you buy funds, there’s no “story” to get into. What’s the story of the S&P 500 Index? It’s a collection of 500 stories, many vastly different from each other. Nothing to see here, so move along.

A little knowledge

And that has been the death of story stock selling. Falling commissions and free fund trading means you just don’t hear those “hot tips” that were common in the 1980s and even into the 1990s, with the Internet boom.

And that’s a good thing. Data from JP Morgan shows that the average retail investor during the 20 years from 1997 to 2016 earned a 2.3% annualized return.

The S&P 500 during that period returned 7.7%. The goal of trying to own the winners while avoiding the losers in the market leads most investors to do quite poorly, just ahead of 2.1% inflation.

The lesson: If you find learning about companies interesting, go ahead and research them. But don’t let a little knowledge drive your investor process. The long run experience is that being too close to the story brings subpar returns at best, even if commission costs are low.

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