While one could make a case either way, investing in this day and age one can't rely on buying and holding as an effective, sure fire method of creating wealth anymore. There are a couple of major factors that make this the case.
1) CEO's are given more monetary incentive than ever before to take gigantic risks to make money for the company. The problem with this is there is no positive results needed to make the money. Just look at Wamu as one example where the top executives were given great compensation for taking risks that ended up destroying the shareholders value and creating enormous write downs for the company. Even as they announced major problems with the risks they had taken they were paying themselves enormous sums of money as if they had done a great job! This is ridiculous and will only continue as there is no accountability for the end result of their bonus driven risk taking.
2) With the advent of the IRA one can make profitable trades in and out of stocks with tax deferred until you need the money. So you can get the tax advantages of buying and holding with the added bonus of being able to respond to changes in the economy through buying and selling. I personally do most of my "trading" exclusively in my IRA account, if you don't have one yet you are missing out big time.
3) Average annual returns, although advertised at 10% or more by financial advisers is actually closer to 5% if you look at the history of the market during the 20th century*. Guess what the compounded annual return has been so far this 21st century, less than 3%*!! With inflation rising to 5% and beyond many times during the same period you actually are losing purchasing power some years further diminishing the returns of investors who buy and hold. Furthermore our economy has seen it's best days and these returns will only get smaller over time if the first 8 years of this century are any indication.
4) The last reason, that is always overlooked, is how companies still "juice" earnings through pension expenses. I won't overwhelm you with the complexity of this sham, but let me tell you that for the majority of companies in the S&P with pension plans they averaged assuming an 8% gain per year! They have the audacity to assume this return year after year even though over a quarter of their funds are in cash or bonds that yield less than 5% per year. Once this is put to rest like the options accounting mess that has taken place in recent years we will see massive restatements of earnings that will only hurt shareholders.
The only reason to buy and hold in this day and age is due to investment competency. If you have done great research and have good competency that there is a long term cycle you can take advantage of then you would buy to take advantage of that cycle and hold for the duration of the cycle. If you don't have the discipline to constantly do research on stocks, bonds, commodities, etc. (bad competency) than you shouldn't be investing in them by yourself. The best thing would be to either invest in an index fund if you are happy with average market returns, a mutual fund with a great fund manager if you like a little more risk, or buy shares of Berkshire Hathaway (brk) which is basically a no fee fund run by the greatest buy and hold investor of all time. For the record, over the last 40 years Berkshire's compounded annual gain has been 21% while the S&P, even with dividends included, has only done 10%!
In the end it is best to be diversified. I have Berkshire Hathaway shares that satisfy my buy and hold area, Asian market driven stocks to take advantage of a long term cycle of growth, and a list of stocks I am currently researching or buying/selling that takes advantage of current conditions in the economy. Also I always remember the old adage of "buy low, sell high" if you only buy and never sell you are not following the most important way to profitably invest. Why not do as I have done with Google over the years, buy it on weakness $350-$450 and sell into strength $550-$650, although I never fully liquidate my position I do reduce it when up and increase it when down.
*All compounded annual gains are calculated from the S&P 500 with dividends included.
2 comments:
That was a well-written and thought-provoking post.
Responses to a couple of quotes:
investing in this day and age one can't rely on buying and holding as an effective, sure fire method of creating wealth anymore.
Correct me if I'm wrong, but isn't at least 90 percent (or more?) of your wealth (if you include property and stock) in a buying/holding pattern? Either way, here's a good question: what percent of your wealth do you use for churning stock? As a reader of all your posts, I'm not so much interested in whether or not gambling is better than investing (since I estimate that you do more investing than gambling anyway), but I'm more interested in your opinion on the ideal percentage of net worth that should be set aside for constant turnover.
Average annual returns, although advertised at 10% or more by financial advisers is actually closer to 5% if you look at the history of the market during the 20th century
Good point, which is why I was taught not buy Indexes (the market's growth, as a whole, is flat compared to the higher quality companies; and I assume that 5 percent statistic includes companies that fell to zero). But there is a way to ensure that you get more than 10 percent on your stock investments: get a good stock broker (know this guy's background, family, names of his kids, everything), and once that trust is there, just buy what he tells you to buy (and of course it's fun to make some of your own picks too).
My stock broker also worked for my parents and grandparents (and his father was good friends with my grandfather), and he's very rarely wrong about anything over the decades (for example, he predicted the dot.com bust, and talked us into sticking with blue chips). And Smith and Barney (his firm) have an entire research department that will help him continue to by right most of the time. Further boosting profits, big firms like Smith and Barney tell all of their clients to buy the same companies, which makes it a self fulfilling prophecy that what they tell you to buy will probably go up.
On top of that, gambling (if done well) is a lot more work, so you have to factor in the time it takes (time is money) to do all the excess research required (instead of relying on a research department). For example, I have to think about the opportunity cost of four hours of stock research (while I already have a whole department that can probably do it more effectively anyway), while I could spend those four hours doing web development and make a couple hundred bucks (I'm losing money as I'm trying this, but this is a pretty good blog, so I don't mind spending the time responding to it).
Not to say I would never gamble myself, but I'd probably dedicate 1 percent or less of my net worth towards that type of fun. And I would think of it like going to Vegas (I'd be doing it just for fun, not because I believe it would make me much richer), just with better odds.
I never fully liquidate my position I do reduce it when up and increase it when down.
That's exactly what our stock broker instructs us to do: when we need cash, we just shave off a little bit from each company, never fully liquidating anything. Sounds like your investment strategy is more buy/hold than it is gambling. So again, I think the discussion would make more sense if we focused more on what percentage of our wealth should be left alone, rather than saying investing (a.k.a. buying/holding) is altogether obsolete.
Thanks for your comments, I appreciate the contribution to this blog!
Some responses for you:
1) I am only referring to stocks when speaking of buying and selling. My property investments are definately buy and hold. For that matter I will only buy property that has positive cash flow so it pays to hold on.
As far as my holdings go here is a break down:
I currently hold shares of 19 different stocks, ETF's, and Funds in my trading accounts. 7 of my holdings have been added just this year so they are short term, And 3 are holdings that I have been buying on dips and selling on upswings throughout the year. So roughly half my trading portfolio is actively traded (meaning short term holdings of less than a year). Of those 9 that I have held for more than a year without selling 2 are funds and 7 are stocks taking advantage of a long term cycles (As I said investing competency)
2) Good stockbrokers are hard to come by, so you are one of the lucky few. Remember though that past returns are no guarantee of future success.
Most intelligent investors missed the huge bust of the dot com bubble but how many have missed the bust of the banking bubble thats currently going on? Most if not all blue chip banks have lost 50% or more of their value during this bust.
3)My buying down and selling up technique is only used for making profits on big movers. I don't sell a little of a position when up I sell about 60-75% to lock in the gain. Most times the shares I keep are all free after making a big run, so I then am "playing with the houses money" at that point.
My post's main point is that the market of today is drastically different than it has been over the last century or even the past ten years for that matter. What has worked in the past will not work in this environment so we must all adapt in order to have continued investing success.
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