BUSINESSWEEK ONLINE : MAY 22, 2000 ISSUE
COVER STORY Online or Off, the Rules Are the Same The Web hasn't changed the fundamentals of smart investing Low-cost online trading has opened the world of equities to millions of people who might not have otherwise considered playing the stock market. More than half of American households now own stocks, and about one-fifth of them made their first investment during the past four years, when online trading became a national pastime. But investors haven't always jumped in with sufficient knowledge. ''The lure of online trading seems to be that here is something you can do with no skill, no knowledge, and yet you can make tons of money,'' says Meir Statman, chairman of the finance department at Santa Clara University's Leavey School of Business. But the past few weeks have been sobering. Nasdaq is down a sickening 31% from its March high. Thousands of dot-com companies are losing altitude fast. Even blue-chip Lucent Technologies (LU), America's most widely held stock, is down about 17% since early March. True, the stock market has usually rallied after its steepest declines. But after several years of historically low volatility, choppy markets have returned with a vengeance in recent months. ''The technology to do trades online, combined with so many inexperienced investors at the leading edge of market activity, underscores the dangerous nature of the market bazaar today,'' says James Griffin, a senior vice-president and corporate economist at Aeltus Investment Management in Hartford. If you're a recent convert to online investing, you may have learned your first real object lessons. No one is saying you should shut down that E*Trade (EGRP) account--heck, even Merrill Lynch (MER) and its full-service rivals are rolling out online-trading accounts these days (page 150). But if the past few months can teach us online traders anything at all, it's that we need to remember some of the basic rules of investing--the ones that long predate the Web: -- Frequent trading can be costly. The average online transaction fee was $23.35 in March, according to Stephen Franco, an equity analyst at U.S. Bancorp Piper Jaffray (USB). That may be cheap compared with traditional broker fees, but it adds up quickly even if you're trading as infrequently as five times a week. Then, too, there are the income taxes triggered by profits from active trading. On a quick trade, you'll pay as much as 39.6% of your profits to Uncle Sam. Buy and hold for just one year, however, and you'll qualify for the lower capital-gains rate of 20%. ''Very active trading will be very unlikely to beat a buy-and-hold strategy,'' says Burton Malkiel, the Princeton University finance economist and author of A Random Walk Down Wall Street (Norton, $29.95 cloth, $15.95 paper). -- Frequent trading may be hazardous to your wealth. The ease of trading with the click of a mouse tempts many people to do it more often. Yet it's tough to beat the market--that's certainly what seasoned hedge-fund operator Julian Robertson discovered recently. Economists Brad Barber and Terrance Odean at the University of California at Davis studied the stock-trading behavior and investment performance of 1,607 investors who switched from phone-based to online trading from 1992 to 1995. The study, available at www.gsm.ucdavis.edu/~odean, found that individuals who made the switch traded more actively and more speculatively than before. And guess what? Their returns went from beating the market by an average of 2% to lagging it by more than three points annually. -- Buying stock with borrowed money can be perilous. Many investors who were caught up in the online-buying frenzy resorted to margin debt or borrowing money from their broker and using their investments as collateral. The level of margin debt surged to record levels over the past year, and profits from margin lending padded the earnings of online brokers such as E*Trade Group, Ameritrade (AMTD), and TD Waterhouse Group (TWE). When the market is going up, buying on margin lets you build your investment position quickly. But in volatile markets, you may be required to put up additional cash or securities to cover any losses. The brokerage firm can even dump your stock to meet a margin call, as many investors have learned to their chagrin. They should have read the fine print in their margin agreements that gave their brokers permission to sell them out. ''The past several weeks have been a lesson in leverage when things go awry,'' says Henry Hu, a professor of banking and finance law at the University of Texas School of Law. -- Being in the right place at the right time doesn't mean you're a brilliant investor. Many of us attribute too much of our investing successes and failures to our own behavior. We feel smart when the market is going up, so we're tempted to trade more and take on riskier positions. We feel stupid when the market is going down, and less sure about our stock picks. -- Know what you are buying. Unless you enjoy gambling on a hunch, you need to delve into fundamentals and try to answer the question: ''What is this stock worth?'' This means not automatically latching onto a stock simply because it's going up. Serious, successful investors still want to know about profitability, management strategy, capital investments, and market share. If you don't have the inclination to educate yourself about individual stock picks, stick with index funds. At least you'll match the market's performance and pay razor-thin fees. Even Warren Buffett, the renowned stock-picker, advocates index funds for anyone unwilling to delve deeply into the economics of a particular business. ''By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals,'' wrote the Wizard of Omaha in Berkshire Hathaway's 1993 annual report. ''Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb.'' -- Use the Internet wisely. Bulletin boards and chat rooms (page 173), with their illusion of easy money and susceptibility to manipulation, are notorious sources of bad information. At least try to verify information from them before you act on it. You may be better off at the sites of major mutual-fund companies, brokerage houses, business and finance publications, and academically oriented finance Web sites. All offer sophisticated insights into the markets, plus a vast array of educational tools. -- Manage your portfolio around the concept of risk. The trick is to mix and match major financial assets to create a well-diversified portfolio with the highest expected return for the amount of risk you are comfortable taking. The Internet offers plenty of tools to help you do that. ''Figure out what you are trying to do, and then find an investment strategy to deal with it,'' says Griffin. The online world allows individuals to participate in the stock market with unprecedented speed. But speed alone is no guarantee of success. Despite all the hoopla over day trading, there is still no evidence to suggest that trigger-happy traders will ever outperform investors who simply buy and hold. By CHRISTOPHER FARRELL _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Online or Off, the Rules Are the Same COVER IMAGE: Our Guide to Online Investing TABLE: Best Bets INTERACT E-Mail to Business Week Online

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