Buy And Hold Is Not A Real Investment Strategy

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Includes: AMZN, AXP, BND, BRK.A, BRK.B, IBM, MAT, NMM, TSLA
by: Matthew Waterman

Summary

While the advice is classic and frequently given, it's really not the way to become wealthy in stocks.

Choose solid businesses, invest regularly, and exploit market volatility.

Above all else, keep at it. Keep buying. Sooner or later, the situation changes.

("Chasing the greased pig", by Richard Doyle, Victorianweb.org) Click to enlarge

One of the classic mistakes I run across with people who are new to investing tends to center around the idea of someone going into the market with some fixed amount in mind. Maybe $100, maybe more depending on how adventurous the person is; buying just one stock, or possibly a few different things and then just sitting on them, expecting that this one action is going to lead them to future prosperity.

The new investor does this because they have heard the advice that long term, "Buy and hold" style investing is the way to beat the market. And it sort of is, but not in the sense that it's just a one-time deal.

Regular contributions are worth more than any research.

Whether you are a deep value investor who spends all their time analyzing businesses, or just the owner of a simple diversified index fund, the thing that makes you wealthy in the stock market is not sitting still. Compounding is what makes real growth happen. That means in order to keep your portfolio increasing at its maximum, you need to have a regular stream of income going in so that the number of shares you own keeps increasing.

You can sort of accomplish that goal with dividend reinvestment and buying dividend growth companies, but that's also not entirely optimal. If you make a one-time purchase and just let dividends be reinvested, then the purchases are going in at the same time every other DRIP investors' purchases are as well. You'll find that those times tend to be when the stock has more price support than usual. If the "Buy low, sell high" advice you may have also heard rings true, then you are generally not "buying low" during that time.

Market pullbacks tend to shake out this style of investor.

I'm not advocating market timing here. That will become more clear as I get into this article further. However, the "one-time" investor inevitably is going to encounter a pullback in the price of their shares at some point. They will think that their understanding of the business, economy, or the markets in general is flawed, and they will give up.

If you are one of the lucky people who happened to make their first investment before Christmas, and arrived here because of the rocky start of the new year we had; if you found this article because you are questioning your decision to invest, then you are taking the first step towards a better future for yourself. It's that questioning of what you are doing that will make your future better.

You might have bought into Amazon (AMZN) or Tesla Motors (TSLA) thinking that they had a bright future ahead and not understood why there has been a pullback of close to $100 a share in Amazon's case, or a 20% pullback on Tesla. I want to recommend that you read my article on the anatomy of a market crash. These two stocks were easily in the #4 section heading into year end.

You weren't necessarily wrong, but now it's time to act.

This is what I mean when I say that "buy and hold" is not a strategy. If I were to write out what I really think the intention behind that advice was, it would be something like "buy and buy and buy and buy and buy, and maybe sometimes sell to rebalance your portfolio".

The end goal is what the new, inexperienced investor has in mind. They are focused on when they can sell, when they can grab that profit that sitting and waiting is supposed to give them. In a perfect world, selling would be something I would never do. If the prices were always good, then I could just keep buying until I could live off of dividends.

If these companies with bright futures really can keep growing forever, then maybe think about adding to what you have. Or maybe for a moment, perhaps I can redirect your focus into diversifying. When I add to holdings, I like to deliberately focus on where there is the most fear at the time.

Take a look at some of these headlines:

Click to enlarge

Pretty frightening, aren't they?

That's sort of the goal if you're a journalist, depending on how you are trying to influence the reader with your opinions. These are from various other news sites, but I admit to also having chosen images in my previous articles that are alarming. It's part of an appeal to fear to get you to read the piece.

However, when you start to read the content of these articles, what you come to realize is that what they were talking about are stocks that are already pushed down in price. The article is trying to rationalize what the fall was caused by. What they neglect to mention is that not every drop in stock price can be explained.

Sometimes stock prices just fall. It's normal.

Navios Maritime Partners (NMM) was in a tailspin thanks to the overwhelming amount of negative news related to the low spot rates in the Baltic Dry Index. But then this happened over the last two days:

NMM Price Chart

NMM Price data by YCharts

From the lowest point the day before, there was an increase in price above 35%. Stocks go up, stocks go down. Calling the precise stock bottom is impossible, but if you had been greedy while others were fearful, you had a chance here to make big profits by ignoring all of the bad news and focusing on what the company was actually earning.

I saw a comment on another article earlier today from a reader who owned something like 10,000 shares at an average cost of $12.00/share, and never added any from the time he first started buying. That person needs to see the stock price increase by 600% from today's price in order to break even. It might take a while.

Even the best investors get it wrong sometimes.

Popular value investments American Express (AXP) and International Business Machines (IBM) had rough first quarters. That doesn't mean that their future is closed off. Both companies have been paying growing dividends for decades now. Warren Buffett is on the board of directors at American Express and has large holdings in both companies for Berkshire Hathaway ([[BRK.A]], [[BRK.B]]).

If the price gets low enough, you have an automatic protection because he will come in himself and buy more. There is nothing he loves more than to buy a great company at a great price.

AXP Chart

AXP data by YCharts

This is my advice: Keep buying.

If the company you are interested in has the potential to keep growing and doing what they do, buy more on declines. Don't worry about when to sell. If you have a job, force yourself to budget part of your income into regularly purchasing stocks, especially the kind that pay dividends. Completely disregard what the market thinks about the future.

One of the stocks I've written about the most over the last year is Mattel (MAT). That was a very hard sell to readers, because all they could see was that the stock was down 50% off its highs. But because I've been making regular purchases every other week, my average cost on the shares is now below what the stock sells for today.

Hedge off a little of what you're putting into your stocks into something like bonds; I use and recommend the Vanguard Total Bond Market ETF (BND). Keep a set amount of your money there, say 20-25%, just to keep from getting too deep into any one single investment; but make your focus on increasing the income that your stocks earn from dividends the priority, not the profit you might make from selling the shares at a higher price. If what has gone down can drop further, then it is also true that what has gone up can go higher.

Keep learning everything you can.

Read as often as you have time for about the markets, about business, about the economy. Do not let fear influence your choices to sell. Buying and selling should always be a decision you make on the future prospects of the business.

Question the reasoning of the author. Consider if what they are talking about has the potential to affect the price of the stock in the future more, of if the stock price has already moved as a result of what the public already knows. Remember that if the news has already been written, then what could happen to the stock price probably already has.

So with that in mind, buy before the good news happens.

I have a series of articles that I'm working on right now that are centered on market psychology and opportunities that have come up due to temporary but solvable economic issues. There are a lot of good deals that have been created recently, and also some pitfalls masking themselves as good values. Follow me for updates, and thanks for reading.

Disclosure: I am/we are long IBM, AXP, NMM, BRK.B, MAT, BND.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.