Sunday, December 5, 2010

Buy and Hold Strategy - Pros and Cons

The so called buy and hold strategy has been popular for amatuer investors or those looking to park some money into the stock market believing that in the long run, they will have greater return on their investments than other asset classes such as property, government bonds or term deposits. There are various indications that show that this is in fact a failed strategy as investors who adopt this will be worse off.

Here is a list of arguments both for and against the Buy and Hold Strategy summarized from the book by Leslie N. Masonson
Buy--DON'T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk

For:
1. Stocks perform better over the long run compared to bonds, treasury bills, cash and is the only way to beat inflation.
2. A diversified portfolio of stock, bonds, mutual funds will provide positive return over the long term.
3. It is better to stay in the market all the time since no one can predict up or down.
4.Stock market always recover and go to new highs, so it is better to be patient and stay with it.
5. If investors miss the best rallies, they will miss out on the best returns so it is better to stay invested in the market.
6.Picking high and low points to sell and buy does not work, so might as well stay invested and also to avoid frequent buy or sell commissions.
7.Only commission is the initial purchase so better to be invested for the long term.
8.Buying no load active and / or passive funds does not incur commission.
9. Rebalancing a portfolio annually to achieve a certain stocks to bonds ratio yearly is good. There are no tax consequences if this is for retirement account (for US holders?).
10. Tax only need to be paid when stocks are sold. For the case of mutual funds, they do pass on capital gains yearly and investors need to pay some tax on this. This is more relaxed for retirement accounts. (for US holders?).


Against:
1. Sometimes may take up to 20 years to break even since there is usually bear market in this time frame. Historically some 20 year period may return negative after inflation is accounted for.
2. Exposed to bear markets and crashes. If you just buy and hold, you will lose what you have gained and need to wait for the recovery.
3. From 1998 to 2009, buy and hold strategy did not return positive return after inflation is accounted for.
4. Diversification may not help as some bear market or crashes affect all industries.
5. There is no defense in a bear market. Buy and hold is only effective during a bull market.
6. Missing out on strong market rallies is not as bad as avoiding the worst daily, weekly drops in the market. Movement of prices in a crash is much more severe than in a charging bull market.
7. Commissions on buying and selling stocks have dropped. ETFs in particular allow exposure to diversified set of stocks.

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