Buy And Hold Isn't Dead, Just Misunderstood

Includes: AA, CSCO, EFA, F, INTC, SPY
by: Geordy Wang

Every once in a while, a bunch of doomsayers pop up proclaiming the demise of buy and hold. This tends to happen more often during times of heavy volatility and uncertainty in the market, such as over the past few months. Some of these folks like to follow up with testaments to the superiority of whizbang new investment strategies, with names like "buy and watch" or "buy and monitor." The problem isn't that they're wrong - on the contrary, they're absolutely right. The problem is that the concept of "buy and hold" that they're attacking is nothing more than a strawman. It's easy to win when you're dueling a scarecrow, because straw doesn't fight back.

Let's look at some articles here on SA that have been published recently: Investors Should Not Be Complacent About Dividend Champions, by James Kostohryz, and Why Picking A Stock To Hold Forever Is Folly: The Apple/Cisco Case, by Roger Nusbaum. First, let me say that Mr. Kostohryz and Mr. Nusbaum are both excellent writers who provide many articles of value to the investment community. I read both of them regularly and will continue to do so. However, both of the articles cited above pick on a premise that was never true to begin with: that the buy-and-hold investment style encourages investors to hang on to their stocks ad infinitum after they've bought them, without paying any attention to how the underlying businesses are doing.

The first and most important rule of buy-and-hold is to know your investments. That includes knowing when to get out. It's very possible for traditional buy-and-hold investors who follow the school of long-term value investing to dump a stock one quarter after they purchased it. Their investment thesis may have been wrong. The fundamentals of the company may have changed. Unforeseen challenges to the business may have materialized. Such an action doesn't diminish the validity of their strategy.

The "hold" of buy-and-hold refers to intent, not a guaranteed outcome. In this way, buy-and-hold investing is kind of like marriage. When we marry, most of us intend and hope to stay hitched for good. When long term investors buy a stock, we hope that the company will continue to grow and remain competitive forever. We select the partner/companies that have the best chance of making that hope a reality.

Of course, a lot of the time it doesn't turn out that way. When you find out that the person you married is not who you thought they were, sometimes the best thing to do is to walk away. When you find out that the business you bought is no longer as strong a competitor as it once was, it may be time to cash in your chips and move to another table.

A character in a great movie once said, "On a long enough timeline, the life expectancy of everyone drops to zero." The same is true of businesses. Of the original Dow stocks, only General Electric (NYSE:GE) remains, and the financial crisis was a pretty close call for GE. Competitive destruction is one of the ugliest, but most fundamental forces of free market capitalism. It doesn't matter how good you are, eventually someone better is going to come along to pick a fight with you, and then it's game over. Nothing immunizes a company from the omnipresent threat of competitive destruction. Not a fat dividend, not a wide moat, not a fortress balance sheet. Eventually, all companies must die.

Buy-and-hold investors understand this, which is why the first principle of buy-and-hold is what it is. The more intimately familiar you are with a company's operations, prospects, and financial health, the more likely it is that you'll recognize when it's time to take your money off the table. No one who actively practices buy-and-hold investing is under the delusion that they must hold on to their stocks forever no matter what happens. Some investors do a portfolio check-up more often than others, but the only investment vehicles that you can just dump money into and then forget about are index funds.

The only reason this is true is because index funds aren't really completely passive. Every stock in an index was added there by a person, and stocks get removed when they no longer fit the profile of the index. When you buy an index ETF like the SPDR S&P 500 (NYSEARCA:SPY) or the iShares MSCI EAFE (NYSEARCA:EFA), you're not holding on to your investments forever either, because the indexes get reshuffled every so often: new companies get added in, faltering companies get taken out. Index investors can afford to be less vigilant because they have the company behind the index acting as their portfolio manager. Investors who choose to pick their own stocks benefit from no such proxy.

If you're not the kind of investor who has the time to stay on top of his portfolio 24/7, there are a lot of companies out there that operate under safeguards that make it less necessary to keep tabs on them all the time. Alcoa (NYSE:AA) plies its trade in a capital intensive industry that poses formidable barriers to entry. Cisco (NASDAQ:CSCO) has a huge war chest stuffed with cash, which helps to buffer against economic assault (though a technology stock is never really a safe investment no matter its balance sheet). Ford (NYSE:F) benefits from great leadership that steered it through a market downturn that swallowed up most of its competitors. The more capable your managers are, the less risk you assume with a hands off approach to ownership. Finally, Intel (NASDAQ:INTC) offers an unrivaled dividend yield compared to its industry peers that continues to grow, which means that by the time cracks begin to appear in the company's foundation, investors may have already made their money back and more through dividends alone.

These companies may have an edge over their competitors in terms of stability, but there's no such thing as a safe investment, only safer. You can call it buy-and-hold, buy-and-watch, buy-and-monitor, or whatever new catchphrase the news streams serve up, but in the end, it amounts to the same thing: buying great companies at a reasonable price, and letting them go when they're no longer great companies at a reasonable price.

Times may change, but the fundamental ideas of value investing, of buy-and-hold investing will continue to remain relevant so long as people in society continue to make money by selling their stuff to other people.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in F over the 2next 72 hours.

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