Buy and hold. And sell?

by Manshu on December 4, 2008

in Opinion

The Buy and Hold strategy is one, that gets beaten a lot in bear markets. There are good reasons for this beating and we will get to that. But, first let us look at what buy and hold means.

This strategy involves buying an index fund and then holding it for a long period of time. This is called Passive Investing and passive investors believe that the best way to earn steady returns is to buy funds at regular intervals and hold them for a long period of time.

Proponents of buy and hold say that active stock management leads to moderate returns, which are not worth the time spent in research or the commissions paid in frequently buying and selling stocks.

The trouble with Holding on

The big trouble with this strategy is that one big slide in the market kills all gains that you have made for a long time, sometimes as long as ten years!

If you bought the S&P 500 eleven years ago and held on to it, you would lose about 6% of your investment. On Dec 05, 1997, the S&P 500 was  983.79 and on Nov 28th, 2008 it was 896.24.

A look at the above chart tells you that you were in a similar situation at least once during the 2000 meltdown, so this is not a one-off situation. Similar conditions have occurred before also and since bubbles and busts are the nature of stock markets, they will continue to occur in the future also.

Don’t forget to sell

Calling a market top is almost impossible, but it is fairly easy to see when markets over-heat. Instead of holding on to stocks perennially, you should sell, when the market is over-heated. There is no reason to not do this.

When stock prices reach levels that do not justify the earnings of the companies they represent, there is no reason to hold on to the stocks. You should convert your stocks into cash in such times.

Don’t buy and sell all the time

This is not to say that one should buy and sell all the time. If you buy and sell all the time, then you will never make any money.

Money will still be made, when you buy and hold for a long time, but you should also sell when the market overheats. Book profits, while there is still time, because every boom will be followed by a bust.

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