If you search the internet, there are plenty of articles critical of the buy and hold investment strategy.
So why do I suggest you employ buy and hold?
Some negative articles do not tell the whole story. The data is cherry-picked to “prove” the author’s point. Always raise a red flag when unusual start and/or end dates are chosen for data.
Some disadvantages relate more to investing in individual, non-diversified assets, rather than the low-cost, highly diversified, fund strategy that I espouse for most investors. A valid issue.
We will review the negatives often raised in conjunction with a buy and hold strategy.
Some are legitimate concerns. Some less so.
Today, the more frivolous.
It’s Too Easy a System to Employ
True.
Taken literally, you buy and then hold until you reach your target date. Then liquidate.
Not that there is anything inherently wrong with this approach. In fact, the ease of buy and hold can be seen as an advantage.
The problem with ease, is that like with dollar cost averaging, too many people believe this system should be used in the literal sense.
They buy, then they forget all about the investment until the time comes to liquidate.
The ease of buy and hold makes certain investors lazy. That is the problem. Not the ease of use.
Regardless of the asset or system employed, investments must be monitored and evaluated. Should circumstances change, portfolio modifications must be made. As well, if your personal situations shifts, you will need to adjust your investing plan. This applies to any trading strategy, including buy and hold.
Buy and hold cannot be rigid dogma. While you will adhere to it for the most part, there must be some flexibility allowed.
We have already discussed how to build a portfolio that minimizes the need to review and make adjustments. That is by primarily investing in low-cost, well diversified, index funds. As we saw, components within indices change over time. Even if your index fund is a buy and hold asset, there may be substantial movement within that index over time.
While minimizing the review process, it does not eliminate the need for periodic evaluations. Nor may it entirely avoid making any dispositions. We will consider portfolio reviews in future posts. Both when and how to evaluate your portfolio, as well as portfolio modifications.
Buy and Hold is Not Sophisticated
So it cannot work well. One needs a complex investing system to succeed. Preferably one with lots of technical data and charts.
Or so some people believe.
Sometimes the simple approaches work well.
But they are not sexy. And, for most investors, it is the lack of sexiness that is the bigger negative than a lack of complexity.
You will sound much more sophisticated as an investor discussing butterfly options strategies around the office water cooler, than in recounting how you have owned the same index fund for the last 15 years.
I suggest you worry less about how you are perceived by colleagues and friends. The purpose of investing is to maximize long-term wealth accumulation. It is not to impress your peers.
Find a strategy that works and stick with it. The grass is not always greener, or more profitable, on the other side of the trading fence. And the people that regale you about profits from their latest trading flips, never seem to mention the ones that lost money.
Buy and Hold Can be Emotional
Another two edged sword for the buy and hold approach.
As an advantage, buy and hold is supposed to take the emotion out of investing. You buy and hold through the ups and downs of the asset’s price fluctuations. You ignore the panic generated by the mass media during bear markets or sudden crashes. You are secure in the knowledge that over the long run, your investment will appreciate.
But this approach is also a disadvantage for many investors.
Holding an investment as month and after month its value diminishes is extremely difficult. In some cases, the value never comes back and you lose.
I can definitely empathize.
The difficulty as an investor is that you seldom are certain which investments will fall to nothing and which are just temporarily depressed.
Do you sell and wait for the asset to reach its bottom before buying back in? How do you know when the bottom has been reached?
Do you sell and shift your cash into another investment vehicle? Will that new asset provide better returns?
Again, find well-diversified and well-managed investments. These will help keep you sane during periodic market fluctuations.
Avoid non-diversified assets (e.g., individual stocks or bonds) until you become comfortable understanding the difference between normal short to medium term price volatility and the permanent impairment of the asset’s value.
Programmed Trading Makes Buy and Hold Obsolete
Computer trading programs are quite popular these days.
More effort is being spent on technical analysis. That is, these programs look at supply and demand for an investment. What are the pricing trends, momentum, and market bands. This type of information is used to assess future price movements.
While some technical analysts take a longer term view of the trends, many try to take advantage of short-term discrepancies that resolve themselves quickly. This can lead to substantial trading and profits can be made on penny fluctuations in market prices.
An argument against buy and hold is that with all the computer models and short-term trading, buy and hold is no longer relevant. The real money is made in the short term and not in holding assets for 20 years.
I do agree that programmed trading by institutions has, and may continue to, caused problems for investment valuations. I think though that these are short-term blips and that over time, asset pricing reverts to its fair value. This actually bodes well for the buy and hold strategy.
I am not a big believer in individuals using computer trading techniques.
I have known certain investors who have done well identifying price discrepancies and short-term trends to arbitrage. But usually you need significant capital to profit on small price changes. This is something that most investors lack.
These investors are also highly skilled and experienced in investing. They use advanced analytical tools. They also devote substantial time to their trading activities. Most normal investors lack the knowledge, tools, and time required to implement these strategies.
I remain unconvinced that, on average, programmed trading by individuals works. As I said, I do know some success stories. And occasionally, one reads news stories about others. But I also know and read about people that win the lottery. That does not mean everyone does.
Okay, those are a few of the less important, but commonly perceived, disadvantages of the buy and hold strategy.
Not really legitimate worries in my mind.
But there are a few real potential problems with buy and hold.
We will cover those next time.
