Why a Buy and Hold Investment Approach Works Best
Meryl is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Stock market investing is all about risk. Individuals who do not want to lose money, cannot sleep at night knowing their account could drop in value, or who might need the cash within the next five years, should not invest in the stock market. No investor, including professionals, famous stock pundits and amateurs, bats 100% all the time. Everyone has winners and losers. With a bit of luck and a lot of hard work, winners outnumber losers. There is, however, no guarantee of investment success.
The only assurance of not losing principal is to buy federally insured securities such as certificates of deposit, hoard cash in a mattress, or stockpile money in a savings account. Interest payments, however, rarely keep up with inflation.
The business dictionary defines financial risk as, “the probability that an actual return on an investment will be lower than the expected return.” Risk can be “neutralized through preemptive action.” It is these ‘preemptive actions’ that separate successful investors from the rest of the crowd.
There are investors who believe they can time the market. Analyzing technical data and/or economic indicators, they decide where the market is headed and trade accordingly. Studies on the success of this strategy is mixed. One study indicated if you were not invested in the market during the ten best market days you missed a lot of gains. The study also showed that if you missed the ten worst days you avoided significant losses.
So should you try timing the market? The problem with short-term market timing is that it is difficult to figure out the direction of the market from one day or week to the next. It can drive the investor bonkers, take a lot of time, and constant trading piles up fees.
Long-term market analysis can shield investors from substantial losses. Investors who believe the market is heading south due to a coming recession or other significant economic event may withdraw funds from the market for months or years. The difficult question then becomes when to wade back in. In the meantime the dilemma is what to do with the cash. In low-interest-rate times such as the past few years dividend-paying stocks provided income difficult to find elsewhere. But to take advantage of the dividends investors must remain in the market.
The following charts illustrate the price, dividend, and dividend yield for AT&T (NYSE: T), ConocoPhillips (NYSE: COP), and Kellogg (NYSE: K) for the past five years. The shaded area are the recession years. Dividend yields for the three stocks are higher than many interest-bearing financial instruments over the same time period. Investors who were willing to accept price volatility and remained invested in the stock market were rewarded with dividends and, eventually, rising stock prices.
Short-term vs. Long-term Investing
There are professional investors and amateurs who try to make money applying short-term trading techniques. The trader continually buys and sells stocks held for brief time periods, sometimes as short as a few hours or days. The investor may realize short-term capital gains, but often the gains are illusory. Trading fees, commissions, and taxes eat into profits. Seldom considered in cost analysis calculations is the considerable amount of time spent finding suitable securities and researching, analyzing, committing to a schedule of on-going scrutiny and trading.
On the other hand acquiring stocks and ignoring them is not an option in today’s volatile, unpredictable, fast changing market. Successful asset growth entails establishing financial goals and developing and executing a wide-ranging, long-term investment strategy. Market conditions change, but over a period of years investors can succeed.
Check out the price chart below for Apple (NASDAQ: AAPL), one of the most successful stocks over the past decade.
The Importance of Being a Proactive Investor
One goal of holding a security long-term is capital appreciation. Keeping an eye on investments helps investors avoid holding securities on a downhill trajectory. The reality of the market is that not all stocks survive and thrive. Securities should be reviewed regularly, minimally once a year and ideally quarterly. Companies heading for bankruptcy usually signal warnings months, and sometimes years, in advance.
Some of the most infamous bankruptcies during the financial crisis include IndyMac, a California-based mortgage lender, and Lehman Brothers, both in 2008. The collapse of Lehman Brothers, a Wall Street icon and financial giant, sent shock waves throughout the financial world. Chrysler went bankrupt in April 2009 and General Motors in June 2009. Some companies reorganize and continue operating, but common stockholders are left with a worthless investment.
One key to successful investing is the ability to let go. Investors get attached to a particular stock and hope the company will resolve the problems. Occasionally it happens, but too often the investor loses money. Do not be reluctant to sell a security when warning signs arise.
Mutual funds and ETFs also require regular reviews. Performance should be compared to the performance of other funds in a particular asset category. If a fund or ETF continually disappoints, sell and move on.
An example of a company sliding downhill that could not execute a turnaround is Eastman Kodak (OTCBB: EKDKQ). Kodak’s stock traded around $90 in 1997. By 2011 it was a penny stock trading under one dollar. The company filed for bankruptcy January 19, 2012. Shareholders had a long time to watch the company’s slow descent and plenty of time to sell and move on.
Keep up-to-date on activities impacting securities and events influencing domestic and global markets. Do not, however, act impulsively and sell on a whim. A winning formula for growing wealth integrates long-term goals with careful planning, account monitoring, and knowledgeable, prudent decision-making.
Does a buy and hold investment approach still work? Yes, if the investor (or a proxy) dedicates time and energy managing a portfolio.
mercyn has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and AT&T.; Motley Fool newsletter services recommend Apple and AT&T.; Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.