|Buying And Holding - Still A Good Idea?|
|Written by Paul Merriman|
What about buy and hold?
There is no question that in the past, buy and hold has worked for patient, long-term investors who can stay the course during the bad times and hang on until the good times return. However, some investors who regard themselves as buyers-and-holders still bail out when the chips are down. In doing so, they usually gain some emotional relief. But here’s the problem: Investors who go to cash in bear markets may be converting temporary losses into permanent ones.
The price of that comfort is the loss of the profits which have always been there for the taking when the stock market has rallied. While there’s no guarantee that a rally will ever take place, history tells us it is highly probable. What’s also highly probable is this: If you bail out when losses get too scary to tolerate, you at some point will want to get back in when things are moving upward. The problem is that when that day comes, you won’t have any objective way to know whether or not it’s the right time.
If you wait until you feel comfortable getting back into stocks, you will probably have missed most if not all of the recovery. You will undoubtedly have “sold low” after a decline spooked you and “bought high” after a rally restored your confidence. This is an example of how our emotions and our herd instincts prompt us to do the exact opposite of Wall Street’s classic advice: Buy low and sell high.
Buying and holding, while it can be very challenging, at least is a system to protect you from your emotions.
Something else we have been preaching for many years is wide diversification. While no sector of the stock market is immune to a global financial crisis, diversification helps. Remember a few months ago when oil peaked at more than $145 a barrel and people were eagerly buying energy stocks and commodities? I wonder how happy they are now, with the price less than half of the summer peak.
Bill Miller became a legendary mutual fund manager, loading up his Legg Mason Value Trust with stocks from sectors he regarded as good values. A year ago, he loaded the fund up with financial stocks, and the media praised him for being far-sighted. In the 12 months ended October 31, his fund was down 55 percent.
Overconfidence isn’t limited to Wall Street. It exists on Main Street, too. I know a 65-year-old man who has an all-equity portfolio, with more than half of it in financial stocks. Most of that was in stock of Washington Mutual, which just last month became essentially worthless. (The shares are reportedly trading on the over-the-counter pink sheets for 16 cents apiece.)
My friend loaded up on Washington Mutual stock because the bank was in an industry he knew and trusted. Now he probably will have to keep working for as long as he is able to. When he finally retires, he and his family are likely to have a much more modest lifestyle than they had been counting on. (For more on the risk that this man took, see “A ticking time bomb: Owning company stock” by Tom Cock.)
Personally, I feel terrible about the losses that almost everybody is experiencing. I believe that recovery will take place, but it may be long and painful, and it certainly won’t treat everybody equally. Like you, I have lost money. Our clients have lost money.
Despite these awful losses, I am proud that our company has always focused on preparing investors for the bad times. It’s always much tougher to face these times in reality than when you’re looking at numbers in a table, and inevitably some of our clients have discovered that they invested too aggressively.
There’s an old saying on Wall Street: The market is a very tough teacher; it gives you the test first and the lesson later. For more than a quarter of a century, we have tried to give “the lesson” to every investor who will listen. We’ll keep doing that for the next quarter of a century, and I hope some people have learned from the present situation that it makes sense to be cautious with money that’s important. I hope they will be ready the next time the market gives its test.