The most obvious one is that it keeps costs down. An investor’s
profits are taxed at a lower rate when he holds his stocks over a longer
period of time. Moreover, commission costs are also lower because the investor
is not trading frequently. The best returns come over a long period
of time because the holding period covers both the lows and the highs, but
over the long term, the market in general tends to go up.
Traditional investment writing has particularly supported the buy
and hold strategy, emphasizing especially the “hold” part of this equation.
In so much investing literature, however, as has been noted above, the
Dow’s rise over the years is used, in our view erroneously, to illustrate
the wisdom of buying or holding any one particular stock. So it would
be stated that if Mr. Investor had the foresight to invest $100 in “stocks”
in 1972, when you will recall the Dow was first at 1,000, then the stock
he invested in would be worth over 10 times that amount today. There
are two problems with this. Assuming Mr. Investor put his money into a
specific company’s stock, and let’s call it XYZ Inc., there is a fault in logic
that we explained above, whereby it is simply incorrect to extrapolate
from the performance of the Dow how any 1972 component (Bethlehem
Steel anyone?) or noncomponent stock would have performed. Second,
such comparisons also leave unanswered the question of what investor
really wants to leave a stock position in place untouched for that amount
of time—35 years in this example. In this scenario, Mr. Investor may have
started to set aside money for his retirement quite early on, adopted a buy
and hold strategy, and 35 years later he still holds the same position and is
now ready to retire. But how common is this investing practice really?
Some investment writers like to go back many more years to make
similar comparisons, sometimes comparing the market 80 or 100 years ago
or more with today’s market to indicate the wisdom of long-term buying
and holding of stocks. This brings to mind the story, most likely a fable,
of the Native Americans who sold Manhattan to the Dutch for $24 in glass
beads in 1626. The moral is one of an incredible investment opportunity
lost by these Native Americans not having held on to Manhattan, given the
real estate value of the island today. This ignores one small fact. Both alleged
buyers and sellers are long dead today! When the experts compare
the investments made many decades or even centuries ago to today’s investments,
as if these truly demonstrate realistic returns, it is useful to
remember the quote from John Maynard Keynes, “In the long run, we’re
all dead.”
In recent years, however, it has been less fashionable for investment
gurus to suggest that the only way forward in investing is to buy a stock
and then simply forget about it for many years. For example, Peter Lynch
has revised this strategy and urges investors to do “six-month checkups”
on their stocks, which includes checking on the price/earnings ratio and
seeing what the company is doing in order to ensure that earnings go up.
In a similar vein, Jim Cramer has called on shareholders to avoid “buy and
hold” but to embrace the practice of “buy and homework,” in which the
investor researches thoroughly and often the companies that he owns.
Other writers today are eager to espouse short-term trading strategies, a
reflection of the shift in trading mentality that has taken hold in recent
years, and has fueled also the heady recent growth of hedge fund trading in
stocks as well as other financial instruments. Professionals and amateurs
alike feel more and more comfortable with the short-term approach and
the search for quick profits.
Read More : BUY AND HOLD - Is It Right?
