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The Buy and Hold Strategy Can Kill Your Portfolio

Category : Personal Finance, Retirement, Smart Investment Ideas

All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies. — Warren Buffett

One of the cornerstone principles of the street smart philosophy is to introspect stereotypical investment ideas prescribed by the main stream media. That includes their buy and hold strategy that most of us mere mortals practice religiously.

Street smarts learn their lessons from the trenches. If you are a buy and hold investor, beware!

The buy and hold strategy can kill your portfolio. Before you shrug off my seemingly unhealthy advice for your portfolio, I want few more minutes of your time to convince you that I am not so naïve.

Three years ago, I met a friend of mine for a breakfast at his house. We set in his porch while someone was taking care of the landscaping work.

Friend:  I lost over $200,000 in AIG stock recently. I was told by my stock broker that you can’t go wrong,  if you follow the buy and hold strategy with a company such as AIG. So, as stock price was dropping — after the market crash in 2008 — I kept selling stocks that made me money to buy more AIG. Now, the company has announced reverse split, and I’ve lost most of my investment.

While he was talking, I was looking at the man who was removing weed and nurturing nice shrubs.

Me:  Investing is lot like your landscape. You need to remove weed and nurture your beautiful shrubs.

Friend:  What do you mean?

Me:  We — mere mortals — do exactly opposite when it comes to investing compare to what we do in our lives with other things. If you are in business, you discount merchandise if it doesn’t sell. We protect our life with an insurance policy.  And we remove weed and let shrubs grow. But when it comes to investing, we sell stock at a discount to feed one that is killing our portfolio. It’s akin to killing shrubs and letting weed grow.

The Buy and Hold Strategy vs The Buy and Beware Strategy

The buy and hold bring complacency. It’s good to invest for the long haul as long as the company you invest in can execute flawlessly by delivering awesome products and services. That usually translates into growing earnings per share, growing sales and growing free cash flow.

The wise man — my favorite Warren Buffett — says that there are two  important factors to consider for the long-term investment.

1.  Picking good stocks at good times

I normally invest in the large cap stocks like Apple, Google, IBM and JNJ.  It’s very important to pick high quality company that dominates its market niche with a major market share. Timing is equally important.

Price is what you pay. Value is what you get. — Warren Buffett

You have to use your judgement, but quality stocks are not cheap. I normally use 50 Day moving average, and buy more shares  in an incremental fashion when stock pulls back near its 50 day moving average.

2.  Stay with the company as long as it is a good company

This is the factor many investors ignore with their buy and hold stock strategy.  The stock market success hinges not only on your acumen to pick great companies, but also on knowing if it remains a great company while you hold the stock.

If a business does well, the stock eventually follows. — Warren Buffett

History has shown that once considered great companies are extinct species now —   Enron, General Motors(Original), WorldCom are just a few names you can think of.  

I read an interesting article recently. The article emphasized that due to dominance of hedge funds and their financial strength,  average stock holding period for all stocks went down to 3.2 months after year 2000 compared to 4 year between 1926 and 1999.

I think this is a powerful transformation we — small, retail investors — can profit from. While major hedge funds influence stock price with their short-term buy and sell in an  ever-changing global economic landscape, you can keep buying shares of a great company like Apple or IBM when they are on sale.

Parting Thoughts:

The buy and hold strategy is neither dead nor less relevant in today’s market; it’s the complacency to ignore facts about your investment that kills your portfolio.

Remember that when you buy shares of a company, you are investing in that business. Like any other businesses that you’ve invested in before, you have to take active interest in gauging your investment regularly to make sure that you are allowing only great companies to remain in your portfolio.

All good things come to an end at some point. Even Apple won’t be able to deliver awesome products for ever.  When that time comes, I won’t hesitate to sell it just because it was a great company in 2012.

Readers: Do you have a disciplined approach when it comes to individual stock investment? When do you decide to buy more or sell certain stock? If you don’t know the answer, it’s always safer to invest in a no-load index fund to protect and grow your hard-earned money.

 The first rule is not to lose. The second rule is not to forget the first rule. — Warren Buffett

Elsewhere:

The Buy and Hold Myth @ Married with Debt

Investing Term Basics @ My Money Counselor

What Phase of Investing Are you In?  @ Work Save Live

Pros and Cons to Investing In the Stock Market Today @ Modest Money

How I Beat Economic Armageddon using a 1031 Exchange @ Financial Samurai

Photo by: Going Concern

 

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Comments (42)

Thanks for the mention Shilpan.

I appreciate your thoughtful approach rather than the rule-of-thumb approach, in this case the rule being “buy & hold.” I believe many such rules have been invented and popularized by the Wall Street marketing machine. As such, they’re mostly about promoting Wall Street’s fortunes and very little about promoting individual investors’ fortunes.

Well said, Kurt! That’s exactly what I wanted to convey in this article.

As a beginner investor I’d probably be leaning towards buy and hold, but only with well established companies such as J&J and P&G. I guess even in that case I should be paying attention to any major changes with those companies. Plus I’ll be including some index funds and bonds to add some stability.

That’s pretty good plan, Jeremy. Both JNJ and PG are great investments for the long time period. The key is not to become complacent about any investment. As Warren Buffett says, “All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies. “

This article says everything that investor needs to know. Not much to add.

“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies. “ This quote tell all you need to know about investing.

I personally like to invest for long term in stocks like KO, JNJ, PG, MCD, IBM (it’s a service company and not a tech company). And hedge them during down cycle and not sell.

I only trade and not invest in all other sectors.

I am not a big fan of technology except for short term trading.

I like your take on IBM as a service company. Not many people know that most of IBM revenue comes from consulting services business.

Great analogy on the garden/landscaping. Thanks for mentioning the buy and hold myth post. That one generated many many emotional comments, and the comment section has become even longer than the post. Have a great week!

Yes, I noticed that. Thanks for stopping by, John!

Well put, Shilpan!

Buy and hold doesn’t mean make only a single decision to purchase and then mindlessly and dogmatically stick to it. It never did.

The term buy and hold is offered not in isolation, but in contrast to what seems to have become the norm, i.e. day trading.

Buy and hold has worked extremely well for me. The few times I dipped my toe in the water to try and be more of an active trader, I lost money. Maybe that’s why I don’t own a hedge fund :)

Any strategy can kill your portfolio if you’re lazy or greedy, just like you said. If you do your homework and are patient, if you avoided companies with excessive debt and without a strong moat, my money says (and proves) buy and hold is still a pretty sound strategy – probably the soundest of them all.

What’s interesting to me is that the people who say buy and hold is dead, usually don’t have a better strategy to propose in its place. And are usually the same people who whine that investing in “Wall Street” doesn’t pay either. As you eloquently pointed out: you don’t invest in Wall Street, you invest in well managed companies.

Well said, William. The buy and hold strategy still works for those who take time to analyze health of each individual common stock they invest in.

As time goes on I may be a little more comfortable investing in individual stocks but as of right now I’m not comfortable with diversification and being in mutual funds or ETFs. The buy-and-hold strategy only works if you’re invested in solid companies but you can’t be complacent and not pay attention to the companies you’re invested in (especially if it’s single stocks). Just like with AIG or Enron, you have to be able to jump ship if things go south.

Most mutual funds under perform an index. Cost is also higher with a mutual fund. Why not an index fund instead of a mutual fund? Or, at least a portion of portfolio should be invested in an index fund.

I love the weeds and the shrubs analogy! It seems so easy when you put it that way, but yet we make the same simple mistakes when it comes time to sell.

One challenge I would throw out to support buy and hold – Doesn’t an Index Fund essentially represent a buy and hold strategy? Are they not successful?

And that’s what I concluded at the end of the article. If you can’t deal with individual stocks, an index fund is a safer alternative. You have to play an active role with an individual stock as you are allocating a portion of your portfolio for that investment. Index fund doesn’t require you to play an active role.

[...] The Buy and Hold Strategy Can Kill Your Portfolio @ Street Smart Finance [...]

It’s all about risk. Can you handle the risk? the more you take, the greater the rewards. But of course like you said, always be aware of what you’re investing. Investing without research is gambling and you know what happens when you gamble?

Investing without doing your own research is akin to throwing dice at the whim. You may end up making a lot of money, or end up losing it all.

3.2 month holding time! That’s horrible. I couldn’t imagine holding a stock for that little time. I agree: that’s a stat you can profit from.

That’s how hedge funds make millions of dollars. But, you can also profit if you piggy back on their power to move stock price in your favor(i.e. when they pull a great stock down).

“As long as they remain a good company.” This is the most important part of the quote. Buy and hold is an enabling strategy for lazy investors. Don’t invest in single stocks if you want to be lazy, otherwise you’ll lose $200k, just like your friend. Once I get a little more cash together for investing, I plan on learning and definitely following the “Buy and Beware” strategy.

I am glad that Warren Buffett is still around. He is a Wall Street sage. :)

I am really enjoying your posts. I am still a little scared of individual stocks, so the indexes seem better right now. Maybe as I keep learning….

I don’t blame you. Always remember what smartest investor on the planet said, “Rule 1: Protect your investment.”

good advice, shilpan!… the reality is that we live in a changing world and the tried and true wall street advice, while grounded in good ideas, is not always applicable.. even the “old reliable” companies may no longer be so reliable in a changing world and changing economy.

So true. I learned that back in early 1900′s few prominent rail road companies were the Wall Street darlings. These stocks reached whopping $500 range in their heydays. Those rail road companies are now gone. Another great company was RCA back when radio was in demand.

Shilpan, Stock market investing requires a tremendous amount of time, research, and attention. Research and my long term experience recommends investing in index funds in an asset allocation that fits with your needs.

I can’t agree with you more, Barbara. Index fund is the safest way to build wealth.

Two thoughts here:
1) Leave the stock picking to the professionals like Buffett and as an amateur just invest in index funds.
2) Buy and hold is only for those who live forever or die alone. Everyone else should do some type of timing on when and what to invest.

Well said, Van! You know better than me on this subject.

Buy and hold has never worked very well. Indexing has its issued too though. First, the drawdowns can be horrible – the last big dip was roughly 60% of the S&P’s value. The second issue is demographics. The stock market boom of 1980-2000 was built on demographics. As the boomers die and are replaced by smaller generations, those demographics work in reverse.

Not a train I want to be on.

Your thoughts are very interesting. Do you mind sharing what strategy you use? Thanks for visiting.

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Making money in the stock market is an illusion – you make money by buying companies and lending money to companies. Hence, a regularly reviewed and balanced portfolio of stocks and bonds as core holdings is key in my opinion.

Why does everybody think that its a decision between trading and buy and hold why not something in between the two.

When I hear Investors talk buy and hold. Im a little confused do they mean buy and hlod forever or buy in hold for a while. I would never buy and hold forever its a bad idea but in some cases its not a bad idea to stick with a stock for many years. That might be five or even ten years.

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