By David Baskin
Baskin Financial is a buy and hold investor. We tell clients to expect a turnover rate of about 20% per year in their portfolios - that is, about two out of ten stocks they own will be sold in any year and replaced with new ones. From time to time we read articles suggesting that buy and hold is dead as an investment method, and that other strategies work better. We beg to differ. Here are four good reasons why we believe that buy and hold is the best strategy for most investors.
1. Good ideas are scarce, by definition. We work hard to come up with good stocks to buy. We do fundamental research and screen many names that never make it into client portfolios. When we do find a stock we like, we will only give it up if we can find another one that is better. We would love to hold every good stock forever, but only a few companies have the kind of consistent performance that makes that feasible. If we can own a stock for five to ten years, that is ample return for the effort spent finding it in the first place. If it is only in portfolios for a year or two, it is usually because something fundamental has changed in the company, in the sector or in the economy.
2. Rising dividends increase return on investment. This sounds obvious, but is routinely neglected by frequent traders. First of all, we must recognize that fully half of the return on the TSX over the past forty years has come through dividends. Dividends tend to rise over time, and since the initial cost of the investment does not change, the cash-on-cash return goes up year after year. Take, for example, Transcanada Corp. (NYSE:TRP), formerly Transcanada Pipelines. On November 30, 2002, ten years ago, Transcanada was paying a dividend of $.90 per share per year, a yield of 4.0% on the then share price of $22.50. Today the same share pays a dividend of $1.76 per share per year, an increase of 96%. The cash yield on the original cost price of the share is now an impressive 7.8% per year. We have no doubt that the dividend will continue to rise. Ignoring the increase in the value of the shares (which have gone from $22.50 to $45.68 over the ten years) the holder of that Transcanada share is now enjoying a return that is far higher than any safe security available in the market.
3. Capital gains taxes are the enemy of long term growth in wealth. There is nothing wrong with taking profits, and we to it regularly. However, when we do, we recognize that for most of our clients, about 25% of the profit will be paid in taxes. The client will have less money to invest, and therefore fewer stocks upon which to receive dividends. Increasing the hold period lengthens the time during which dividends are received and during which they compound on the entire amount of the investment, not just the amount remaining after capital gains taxes are paid.
4. Buy and hold cultivates a more patient investment sensibility and makes investors less prone to panic and impetuosity. The investor who is constantly buying and selling becomes hyper-sensitive to every bit of news, gossip and rumour. Stocks are sold for bad reasons and bought for worse ones. During market sell-offs frequent traders sell as stocks fall, usually too late, and then try to buy back in, usually too late - since experience and research have shown such market timing is virtually impossible. During market bubbles they inevitably follow the herd and pay too much. In contrast, buy and hold investors know that every market up and down is just part of a long cycle, that quality companies and quality stocks will hold their value, and that trying to time the market is a fool's game.
We recently reviewed the largest twenty equity positions in our client portfolios over each of the past three years. We found that fifteen of the twenty stocks had been in the top twenty list for each of the three years, with some movement in position on the list due to market price changes. Fifteen out of twenty over three years is probably as much as one can hope for, given changes in the economy and in the world. For us and our clients, we prefer to call our strategy buy and prosper.