The consequences of the buy and hold investment strategy.
During volatile periods like we have right now, the standard advice I’ve pretty much followed as a long-term investor boils down to the following points:
- Perform asset allocation.
- Diversify.
- Evaluate your portfolio and rebalance it regularly.
- Stay in the market for the “long term” or until you finally address your financial goals.
- Use index funds or ETFs.
This is basically our investment philosophy in a nutshell. But I’d like to take a closer look at a few more investment approaches I’ve tried time and again in the course of my investment “career”.
Long-Term Investing vs Short-Term Trading
In past articles, I’ve discussed the concept of day trading, and have covered long term investing vs short term trading strategies. Short-term trading hasn’t really been my investment approach of choice, although I’ve tried my hand in it in the past, and I do know many people personally who are successful at participating in this form of market play. Of course, the difference between my trader friends and me is that they actively follow the markets and their investments on a daily basis, while I leave my investments in auto-pilot for the most part. I’m just unable to commit an inordinate amount of time to my investment portfolio as I’m busy enough as it is.
For a passive investor like me who subscribes to long-term investing and indexing, and who limits market timing to a small portion of my portfolio, this may indicate that I’m pretty much one who buys and holds. But in reality, I also don’t believe entirely in the concept of “buy and hold”. I don’t think that buying and holding should be considered synonymous to long-term investing because it insinuates that your strategy compels you to stay put in a particular investment forever (no matter what). Instead, I’d buy and hold according to the parameters specified by my specific asset allocation and long term investing goals.
The Buy and Hold Strategy
Buy and hold is the antithesis of day trading. However, either strategy can be problematic if applied unchecked. With day trading, we can’t help but keep our eyes obsessively on the markets, while with buy and hold, we neglect our positions and may not be checking our portfolios often enough. Buy and hold seems to have worked well if you were in US equities over the span of a lengthy bull market:
My Oracle Stock Story
I still recall the story of a friend of mine and former co-worker who, along with me, owned shares of Oracle stock in our ESPP plans. We roughly had the same amount of shares in our accounts. The difference though was this: I sold my shares early while my friend held on to hers, even quitting her job to go on an around-the-world trek for an entire year; a trip that was fully subsidized by occasional sales of her stock.
The irony here was that she came back to even more money than she started with (despite not working for a year), thanks to a strong market and a buy and hold strategy. I, however, was still toiling away at my job after that same year — with not much growth in my investment balance — having given up the ride on Oracle too early.
Yeah, this sure is a fantastic strategy if the long term trend is up, which is what everyone expects. U.S. bull markets have been kind to investors, but now that we’re in bear market territory, it’s a whole ‘nother story. In the case of a prolonged slump, what you’re buying and holding is “dead money”.
Evaluating Your Long Term Investment Horizon
Take for instance the situation we have today: if you’re close to retirement — even 10 years is fairly close(?) — then getting caught in a long-term market slump like what we’ve seen with Japan, or something like what we’re experiencing right now in our very own U.S. stock market could throw a monkey wrench in your retirement plans.
The problem here is not that long term investing has failed us, but that it’s been misapplied. As investors, maybe we’ve become too inflexible about our portfolios and have forgotten about the risks, having been spoiled with awesome returns throughout the boom years. Without practicing appropriate asset allocation (where you dial back the risk over time based on various factors) and misinterpreting what “long term” means, an investor becomes vulnerable to potential losses. In my opinion, it’s all a matter of semantics, and perhaps we’ve simply forgotten that long term is not 5 years or 10 years — it’s 25 years or longer (thanks to Wealth…Uncomplicated for this reminder!).
I believe long term investing is still the way to go, but we’ve got to be careful about defining what this means. You’ve got at least 25 years still left? Then embrace the market and the opportunities it presents today.
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You don’t have enough time to invest in stocks for the purposes of paying college. The risks at this point are too high. If there is a market swing, and there are plenty these days, you will be wiped out. Need shorter time, more secure investments. And, they will not yield too much, but are safer.
I agree with your point that “long-term” has been applied too liberally. Each investor should assess their own investment horizon and allocate their portfolio accordingly. Too many people have come to financial ruins by mismatching their cash flows. I have a guest post coming out at Jeremy’s Gen X Finance next week that will also talk about this. Great post, long term is not always synonymous to buy and hold!
What’s interesting to think about is how even buy-and-hold is pretty frenetic compared to other economic activities: people rarely change careers more than once or twice in a lifetime, and don’t change homes very often, either, but see nothing contradictory about having a portfolio that is 20% insurance companies one year, and 20% router manufacturers the next.
Some of this is because the transaction costs are lower for stocks — but if you trade a lot, they really add up.
Slow and Steady wins the race. That has become my financial motto. And I intend to take it slow and steady.
-Nate
Part of me is glad the market fell, it lets me buy a little more, and part of me is sad because I know a lot of near retirees were hammered because they made some poor allocation decisions. It’s bringing the idea of asset allocation back into play, which is good, but a little too late for some. Unfortunately, this stock market fall is coupled with a broader recession (unlike the dot com boom) so it’s harder for near retirees to find jobs to cope.
Too much media junk touting buy and hold is dead, but if we keep buying some good companies at todays prices, we’ll prove whether it is dead or not.