Hi There !

I am trying to find some data I read about a few weeks ago.

Apparently, a finance professor simulated buying 200 stocks.  All 200
were chosen at random (i.e., by throwing darts at a dart board).

Any stock which declined 5% or more from the purchase price was "sold"
from the portfolio.  All the remaining stocks (in the range from minus
4.99% to plus 100%) were retained in the portfolio.

The portfolio apparently did very well, beating the S&P 500 year after
year.  The professor's point was this:  it doesn't matter how you pick
stocks.  It only matters that you sell losers and keep winners.

This "simpleton" approach sounds too good to be true.  On the other
hand, it is intriguing given many people refuse to sell losing stocks
while they're still down.   In my own experience, a single bad stock
can overwhelm an entire portfolio of good stocks.

A 5-star answer would be finding this study (or two studies similar to
it) which discusses "money management" rules as opposed to "stock
picking" rules.

All comments greatly appreciated!

Thanks.
ron

Radio presenter Jeremy Vine carried just such an experiment on his
afternoon radio show (BBC Radio 2). He can be contacted at
vine@bbc.co.uk where I am sure he would be pleased to help with your
enquiry

rabaga---you are terrific!  Very thoughtful of you.  I'll contact Mr.
Vine right away.

Thanks.
ron

This would work quite well if you start with a million dollars at the
beginning of a long rise in stock prices, otherwise the brokage fees,
are likely to take most or all of the profit. Doing this with 5 or 10
stocks instead of more diverity, could mean a streak of bad luck and
errors produced a loss as large as 50% in a single year. You probably
should not sell a stock that lost 5% if the The S&P 500 droped several
percent in the same period, but It might be wise to sell a stock that
lost 1% if the S&P was up several percent in the same period. The
process of "getting rich" in the stock market is a bit more complex
under most real world conditions. Making sell decissions based on the
price you paid several years ago, does not seem logical to me.  Neil

I believe that the random stock portfolio is something that may work
out in theory, but ultimately falls apart when you try to put it into
practice.

A random portfolio of 200 stocks might outperform the S&P, but even
with a cheap online brokerage account that only charges $10 per
transaction, you're still looking at a $2,000 expense just to get
started, versus one purchase of an S&P index fund for $10.  When you
sell your stocks for losses (or to realize your gains) that will be
another $2,000 in guaranteed future expenses as well.

If you have $100,000 to start with (a generous amount for the average
investor), your portfolio will have to perform 4% better than the S&P
over that time period just to realize the same benefits as an S&P
index fund.  The less money you have to start with, the more daunting
your initial penalty that must be overcome becomes.

There's another issue to consider, especially if you have more than
$100,000 to invest.  If you sell only stocks that lose 5% in value,
you will amass a large number of short term capital losses, without
any gains to offset them, so you stand to give away a lot of potential
tax benefits when you eventually realize your gains.

Hailstorm made some good points. 200 stocks, 100 shares each = 20,000
shares at an average of $5 per share = $100,000. That means few mid
priced stocks can be purchased and hardly any high priced stocks,
unless you cut the 200 to about 20.
 The noron plan seems to call for selling the stocks automatically
when they have doubled = 100%. This will be too late for most cyclical
stocks unless the S&P is rising during most of the period and too soon
for some non cyclical stocks in a rising market.
 Several years of mostly falling stock prices, means few, perhaps none
will be sold because they doubled to offset the thousand stocks you
sold because they dropped 5% a few weeks (minutes?) after you bought
them. 2000 trades at $20 average trading cost = $40,000 in trasaction
costs plus 2000 hours of your time if you give an hours analysis to
the average trade. Your tax accountant will want several hundred extra
dollars to process 2000 trades.  Neil

neilzero---thanks for all your comments.  Incisive!

ron

P.S.   As you suggest, my accountant loves my stock market ideas...heh  heh  heh

hailstorm---you are absolutely correct.  Fortunately, I have a new
flat-fee account that does not charge per trade.

On the subject of taxes, isn't the scenario you suggest a good thing? 
In other words, if one constantly realizes losses while leaving gains
unrealized, doesn't that push taxes further and further into the
future?  Similarly, wouldn't short-term losses (stocks declined more
than 5%) cut my tax bill now, thus leaving more money to
invest/compound?

I know little about taxes---never had the skill or patience.

Thanks again for your comments.
ron

I think you can only carry over about $1500 of your losses for up to
one year.  Other than that, it's "use it or lose it".

And please tell me more about this "flat fee" trading account you have!  ;-)

Thanks again, hailstorm, for your comments.  The flat-fee account is
called a "Passport Account."  Several different investment firms have
started offering these in the last 6 months.

Charles Hartley opened my account.  His number is (800) 365-5726. 

Good luck!
ron

Actually, any capital losses you incur (at least in the United
States), can be carried over to successive years to offset any capital
gains for tax purposes.  The carryover limit refers to the $3000 limit
on the capital loss that you can use to offset *ordinary income*.

Example:
You incur $15,000 in capital loss in 2004 by selling your 'losers'
that drop below 5%.  You incur no capital gains.  You can use up to
$3000 this year to offset your ordinary income.  $12,000 of capital
loss rolls over to 2005.

You incur $9,000 of capital gain, $1,000 of capital loss in 2005.  The
$1,000 of capital loss offsets the $9,000 of gain for a net of $8,000.
 Then, you use your $12,000 of capital loss from 2004 to offset the
$8,000 of capital gain for 2005.  You now have 0 capital gains (with
respect to taxes) and $4,000 left of rolled-over capital loss.  You
can still use up to $3,000 of that to offset ordinary income.  You do
which means you have $1,000 net capital loss than can be rolled over
to 2006.

In 2006, you sell everything for capital gains of $23,000 and a
capital loss of $4,500.  Again, 100% of the capital loss can be used
to offset any capital gains, so you end up $18,500 net capital gains. 
Then you can take the $1,000 capital loss rolled over from 2005 to
offset the rest.  You capital gains taxes on $17,500 and income tax on
your ordinary income with no offset as normal.

-The Grammaton Cleric

Grammaton Cleric,

Thanks for the grrreat example.  If I join your church, can we talk
stocks in the back pew?   heh  heh  heh

Thanks again.
ron