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Some Thoughts On “Buy And Hold” Investing

17 November 2009 No Comment

Most investors are told that you can’t time the market; therefore, you should buy and hold indefinitely.  The other reason quoted for this strategy is that over time, enough time, stocks always do well.  I’d like to address both of these ideas.

“You Can’t Time The Market”

This is an interesting statement, because it’s very vague.  Think about it.  What do you mean by “time the market”.  Do you mean identifying the exact bottom or top?  Or how about within 10% of a top or bottom.  What does it mean?

Of course, it’s tough, maybe impossible, to pick the exact top or bottom of a market.  But, this isn’t as important as you might think.  The key is to time the market enough to identify better buying opportunities than simply investing the same amount each month or each defined period.  Is this possible?  I think so.

“Over Time, Stocks Always Outperform”

I can also bring some potential issues to this surface regarding this idea.  First, history doesn’t always indicate future performance.  Most people look over the past 100 years with also coincided with a large rise in America’s power and economic ability.  More recently, it coincided with a large debt bubble.  I can think of a good amount of very smart people who think there’s a great chance that America declines in the coming years, or maybe that America’s best days are behind her.  If this is accurate, will stocks always still outperform?  Maybe, maybe not.

If you bought stocks 10 years ago, you’d have lost money when you factor in inflation.  If you bought gold 10 years ago, you’d have more than tripled your money.  Does this mean gold will outperform over time the stock market?  Not necessarily.  My point is that you shouldn’t blindly accept that stocks will always do well over a long enough time period.  Who pushes this idea the most?  Financial advisors.  Do they have a stake in the public embracing stocks?  Yes.

A Better Buy and Hold Approach

Rather than blindly buying stocks every month (leave that to your 401(k)), let’s take a look at a better way.  First, you need to identify what level of activity you are comfortable with.  If you have a long term perspective on your investing, consider buying stocks only when the stock market is down or flat in recent months/years.  This is your effort to buy at lower prices than traditional “buy and hold” folks.

If the market is in a definite bull market, maybe consider slowing your buying.  If the market really spikes in a short time span, stop your buying and if you’re comfortable with a more active approach, consider selling a portion of your portfolio to raise cash.  The key here is to be patient because you have a long term perspective.  It’s very easy to give in to an emotional response.  The most common one is during a big rally (like summer 2009), when investors panic and think they are going to miss out on this run.  The most common result is people buying late and buying stocks at high prices (and usually losing money).  The patient, long term investor will wait out a fierce rally or even raise cash.  Don’t be afraid of having cash; you don’t have to buy stocks just because you have cash sitting idle.

Lastly, use dividend yields as indicators of when to buy.  A company’s dividend yield will rise when its share price goes down (be careful with yields over 10% as this might indicate a troubled company and potential dividend cuts).  Buying a stock will lock in the yield at purchase time (barring any change in dividend payouts), which means you will still collect the same return on the money invested even if that stock price rises.  When you buy a stock that is overvalued, you not only lock in a lower dividend yield but there’s greater risk for loss in share price.

If you have a 401(k), I definitely recommend doing this approach with capital outside your 401(k) because you’re already doing blind buy and hold investing by investing the same amount each month in a specific allocation regardless of stock market levels.  If you don’t have a 401(k) and have no other market exposure, you may or may not want to be an “active buy and hold” investor; it depends on your experience and comfort level.  Obviously, all investing involves a risk of losing money.

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