Stock markets around the world have depressed, scared and concerned a lot of people.
For many people, the advice coming from the financial industry is ‘hang in there and eventually things will come back.’ For the most part, this advice is the right advice. Statistics suggest that when you look at the stock markets, they go up approximately 70% of the time and they go down about 30% of the time, which means that if you can just get through the bad times, the good times will more than reward you. In fact, the ups in bull markets last three to five times longer than the downs in bear markets. The gains of gaining markets are typically five to ten times bigger than the downs of losing markets.
Based on these statistics, buy and hold works 70% of the time, which are pretty good odds to live by in stock market investing. Although buy and hold is good practical advice, there are some situations where buy and hold does not work.
I’ve always said that if you buy crap and hold crap, you will always have crap. Buy and hold is a strategy that works if you buy the stock market as a whole. The market is measures by an index, which contains hundreds of different stocks. A market index is diversified because it is like a weighted average of a whole bunch of stock some of which may be good stocks and some which may not be so good.
For investors who buy individual stocks, it is very important to avoid crap because sometimes crap may not come back. The key to avoiding crap is good research. At times like these, if you are concerned about your holdings, take the time to revisit your holdings and see if they still represent quality. Quality investments will go down from time to time but if you hang in there, quality typically comes back.
In the mutual fund industry, investors are also advised to hold through these tough times. Mutual funds are like market indices from the perspective that they have a broad range of holdings as a means of diversification. From a buy and hold stand point, one might argue that buy and hold is a good mutual fund strategy. That being said, I also believe that there are good quality mutual funds and crappy mutual funds so researching and selecting mutual funds is also important. Be careful about holding mutual funds with high management expense ratios (MERs) for the long term. Fees can be one of the biggest reasons for underperformance over the longer term.
Systematic withdrawal plans
The other time buy and hold does not always work is when you are taking out income or making withdrawals from your investments. Retirees who are withdrawing money from their portfolios get hit the hardest when markets fall. Taking out a set amount of income from portfolios by selling units of investments can reduce longevity when markets drop severely. Selling units or shares when markets drop in value means there is less money to help recover when markets rebound. Mathematically, drawing income when markets are down increases the risk that the portfolio will run out of money a lot sooner.
My two cents
Buy and hold is common advice that seems to make sense in most situations. I also think buy and hold is advice that can be over used and sometimes abused by the financial industry. Buy and hold should never be an excuse to avoid research. In times like these, make sure you are holding onto good quality investments that will rebound when the markets come back. And don’t worry, the markets will come back . . . I just don’t know when it will happen.
All this being said, buy and hold ignores one of the key components to making money. It ignores the fact that you have to sell to make money. You’ve heard it before . . . the best way to make money is to buy low, sell high. Make sure you develop a sell strategy in your investment process.
If you like this article, check out Jim’s new AUDIO CD recording called Investing is not Rocket Science: How to become a successful investor.