Most of us hear the advice- “Buy XYZ stock and hold it for a long time”. These advices are more rampant when markets are down and the current stock prices are usually below your purchase price. This is because no “buy and hold” expert wants to acknowledge his/her mistake . So till the stock price gets above the recommended price, you can continue to increasing the holding period ( From 1 year to 3 years to 5 years to even 10 years). Some might even recommend to buy even more while the stock continues to fall! I don’t blame them-after all their job is to offer you some hope in bad times.
There are couple of things which I have observed for “buy and hold” investing. One thing which often gets quoted in favour of “buy and hold” is that it is not possible to time the market. Of course, I can’t pick tops and bottoms but one can’t surely pick a few uptrends and avoid a few downtrends.
Secondly-people often quote the famous Warren Buffet while advocating “buy and hold” strategy. Now can you be as patient as Warren Buffet in holding a stock like Coca Cola for last 10+ years without generating any significant returns. He holds Coca Cola for its “brand value”. Mr. Buffet can afford to “own a business”and influence the way it is run. Can an ordinary investor emulate that? How many “buy and hold” investors can stay on cash like Mr. Buffet did from 2004-2007 (during the great bull run) ?
I feel that “buy and hold” carries a lot more risk for a normal investor.
From the recent memory take a stock like JP associates. The stock went from 150 in June-July 2007 to 500+ in December 2007, only to fall back to 200 in January 2008.
If you consider a “buy and hold” investor who bought at 150, he would have made 30% on his investment but his drawdown from the top would have been 60%(risk). And those who bought at above 200-250 might have experienced a negative return.
Now lets take the case of picking a few trends. Even if a trader bought at 170 and sold at 400 or even 350 (not at the peak of 500), he/she would have made a return of more than 100% (in 6 months) while having a drawdown of just 20% from the peak (your risk). Doesn’t it offer a better risk/return profile?
Another advantage is that “buy and hold” guys never know when to cut their losses . They are so blinded by their hope and conviction that they sometimes miss the real picture. Take the JP associates example again. When do you think will the “buy and hold”investor bail out? Add to it the psychological pain of seeing such huge drawdowns (50-60% sometimes) in “buy and hold” strategy. It shakes your confidence and affects your mental ability to seek superior performance in the markets.
On the other hand, if you are trading the momentum you are always prepared to cut your losers(again not easy!) and get the best out of your winners.This results in better risk adjusted returns.
The only word of caution is that you don’t want to be over leveraged while trading trends. This is because one bad reversal can ruin your trading account!
“Buy and hold” is more about the future and I feel future is unknown. Do you know how stock markets shall look like in next 10 years? Would they still be generating 20% per annum returns or will the returns shrink to 5%? Is it a good idea to hold a stock for 10 years when you don’t know its future?
Many people ask me to recommend a stock they can hold for the next 10-20 years. Although I personally like a stock like Reliance which is in long term uptrend but I am not too sure if it shall stay that way for next 10 years. What if oil falls back to $30/barrel? Will Reliance stay at these elevated levels? What will a buy and hold investor do if Reliance stock reverses sharply in case of such scenarios?
Thats I why I feel uncomfortable giving such “buy and hold” recommendations. To me they appear more risky as it involves a lot of guess work.To me a simple”buy and hold” offers no real edge to the investor.
- SageCapital
There are couple of things which I have observed for “buy and hold” investing. One thing which often gets quoted in favour of “buy and hold” is that it is not possible to time the market. Of course, I can’t pick tops and bottoms but one can’t surely pick a few uptrends and avoid a few downtrends.
Secondly-people often quote the famous Warren Buffet while advocating “buy and hold” strategy. Now can you be as patient as Warren Buffet in holding a stock like Coca Cola for last 10+ years without generating any significant returns. He holds Coca Cola for its “brand value”. Mr. Buffet can afford to “own a business”and influence the way it is run. Can an ordinary investor emulate that? How many “buy and hold” investors can stay on cash like Mr. Buffet did from 2004-2007 (during the great bull run) ?
I feel that “buy and hold” carries a lot more risk for a normal investor.
From the recent memory take a stock like JP associates. The stock went from 150 in June-July 2007 to 500+ in December 2007, only to fall back to 200 in January 2008.
If you consider a “buy and hold” investor who bought at 150, he would have made 30% on his investment but his drawdown from the top would have been 60%(risk). And those who bought at above 200-250 might have experienced a negative return.
Now lets take the case of picking a few trends. Even if a trader bought at 170 and sold at 400 or even 350 (not at the peak of 500), he/she would have made a return of more than 100% (in 6 months) while having a drawdown of just 20% from the peak (your risk). Doesn’t it offer a better risk/return profile?
Another advantage is that “buy and hold” guys never know when to cut their losses . They are so blinded by their hope and conviction that they sometimes miss the real picture. Take the JP associates example again. When do you think will the “buy and hold”investor bail out? Add to it the psychological pain of seeing such huge drawdowns (50-60% sometimes) in “buy and hold” strategy. It shakes your confidence and affects your mental ability to seek superior performance in the markets.
On the other hand, if you are trading the momentum you are always prepared to cut your losers(again not easy!) and get the best out of your winners.This results in better risk adjusted returns.
The only word of caution is that you don’t want to be over leveraged while trading trends. This is because one bad reversal can ruin your trading account!
“Buy and hold” is more about the future and I feel future is unknown. Do you know how stock markets shall look like in next 10 years? Would they still be generating 20% per annum returns or will the returns shrink to 5%? Is it a good idea to hold a stock for 10 years when you don’t know its future?
Many people ask me to recommend a stock they can hold for the next 10-20 years. Although I personally like a stock like Reliance which is in long term uptrend but I am not too sure if it shall stay that way for next 10 years. What if oil falls back to $30/barrel? Will Reliance stay at these elevated levels? What will a buy and hold investor do if Reliance stock reverses sharply in case of such scenarios?
Thats I why I feel uncomfortable giving such “buy and hold” recommendations. To me they appear more risky as it involves a lot of guess work.To me a simple”buy and hold” offers no real edge to the investor.
- SageCapital
) he would have retired in a year.