Strategy
What an Aspiring Buy and Hold Investor Should Consider
By Henry V. Kaelber
President, Chief Investment Officer, Hoffman, White & Kaelber Financial Services, LLC
The buy-and-hold is said to be the most commonly used investment strategy among individual investors. Many choose this method because of its simplicity – buying a stock and holding onto it, no matter how much the price rises or falls.
Buy-and-hold investors usually sell their stocks only when they have reached a certain goal such as making enough money for retirement, a college fund, or a house. Investors can buy a stock, hold onto it, and not have to worry about the right time to sell. Two additional benefits to the buy and hold strategy are that trading commissions can be reduced and taxes can be reduced or deferred by buying and selling less and holding longer.
The "buy and hold" approach to investing in stocks rests upon the assumption that in the long term (over the course of, say, 10 or more years) stock prices will go up, but the average investor doesn't know what will happen tomorrow. Historical data from the past 40 years supports this claim. The logic behind the idea is that in a capitalist society the economy will keep expanding, so profits will keep growing and both stock prices and stock dividends will increase as a result. There may be short term fluctuations, due to business cycles or rising inflation, but in the long term these will be smoothed out and the market as a whole will rise.
Market timing is an alternative to buying and holding. Market timers believe that it is possible to predict when the market, or certain stocks, will rise and fall. Does it therefore make sense to buy when the markets are low and to sell when they are high in order to maximize profits?
Investing is a process of making decisions today to achieve results that will not be known until tomorrow. Because nobody can control everything that is going to happen tomorrow, nobody knows what tomorrow will bring. As such, most experts agree that market timing is incredibly difficult if not downright impossible. They also warn against it because:
It's hard to say when the market or a particular stock is "high" or "low".
Commissions and or bid/ask spreads eat away at your profits when you trade frequently, especially on small transactions.
In the last 40 years, the market returned about 11.3% annually. If you were fully invested the whole time, but got out completely for the 40 best months, your annual return would've dropped to 2.7%. If you miss the big moves, it hurts, and no one really knows when they're coming.
But, buy and hold doesn't work for most people because most people, for one reason or another can’t seem to stay in the game! Here are some reasons why:
The market can easily move sideways or down for periods of 10 years – buy-and-holders can lose money for 10 years! Think of a retired household whose living expenses are paid from savings. Do you think this might impact one’s life style?
Bear markets may seem insignificant when you have only $10,000 invested, but what about a hard earned portfolio of $500,000. Every time the market falls 5% you've lost $25,000. Now, imagine the market correcting by 30% over several months - you've now lost $150,000. The pressure to sell out and save your remaining $350,000 will be very difficult to resist.
Most people give up and sell out very near the bottom. That's what emotions will do for you. It's very easy to say you'll ride out a bear market while the market is soaring, but almost impossible when the market is crashing and all you hear from the media is how the market is going down to zero.
This is the problem with Buy and Hold. It's easy to stick with when the market is rising but impossible when the market is falling. If you think you're different and can ride out a bear market you'd better think again about how emotionally painful it will really be.
Despite battling the odds of uncertainty, most money managers are practicing some form of market timing. But the truth is that most timers are trying to flatten out the risk and volatility in a portfolio, and are willing to trade some returns for stability.
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