Al Frank (4)

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In addition to stock diversification, Al Frank also discussed time diversification, i.e., how long does an investor hold a stock he or she has purchased.  In these days of split second trades conducted by extremely fast computer programs, such an idea seems old fashioned.  Since few individual investors have the financial resources, time or ability to set up a computer programmed investment system for successful trading in and out of the market every minute, I believe the old fashioned way of investing is still relevant and preferable for the individual investor.  Mr. Frank discussed diversification as follows:

Diversification refers to stocks, industries and time.  Stock diversification is the spreading of individual stocks and corporate risk by obtaining as many different stocks in different industries as is reasonable and feasible with one's resources.  Time diversification is the holding of positions for as long as their fundamental analyses indicate their undervaluation and potential appreciation, because studies have shown market risk is thereby reduced.  Few investors seem aware that time diversification is more important than stock diversification.  Generally the longer you own a stock (of a viable business) the less risk you engender.

Mr. Frank wrote about a study published in the Journal of Portfolio Management, which measured the reduction of risk achieved by holding stocks for longer periods of time.  The study had the following results:

Testing portfolios varying in size from 1 to 100 stocks, with holding periods from six months to six years, "[The researchers] concluded that a 1-stock 'portfolio' held for one year was less risky than a 100-stock portfolio held for a single six-month period."  The authors also found that holding a 10-stock portfolio for four years was one-third as risky as holding a 100-stock portfolio for one year.  There is a common sense rationale for the statistical probabilities of time diversification.  For any relatively brief period, the market can have a selloff that carries most stocks down without regard to each of their corporation's fundamentals.  This is called market or systematic risk.  But over longer time periods, the aphorism "Value will out" tends to prove true. 

In order to hold a stock for a long time, the investor must have a very important trait: patience.  He or she must have the patience to weather the ups and downs of the market and to continue holding a stock despite its short term movements.  To have the necessary patience, the investor must believe in a system of investing.  Patience is only possible if the individual has confidence in his or her chosen investment strategy.  Mr. Frank summed it up as follows:

Maintaining our analytic methodology, portfolio strategy, and steadfast patience even though some of our stocks or the market in general takes a tumble are practical applications of rule utilitarianism.  When you believe in your system, in the long-term advancing nature of undervalued stocks and the market on average, then you are able to hold an undervalued stock through its recurring downward fluctuations in market price, even through a 50 percent or more decline in price.  In this regard, Buffet has pointed out that, "You ignore that possibility at your own peril.  In the history of almost every major company in this country, it has happened.  you shouldn't own common stocks if a decrease in their value by 50 percent would cause you to feel stress."

We will end our review of Mr. Frank's classic text on this note.  We will return to his book in the future since he also explains other investment strategies, but he remained committed to value investing as his core philosophy.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

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