Investors know the literal meaning of “buy and hold” but may not understand and do what it means as part of an investment strategy.
Buy and hold <what> matters.
Not all stocks (companies) are the same. Not every company can be Apple, Google, Amazon, Netflix, Starbucks, or McDonald’s. Many companies do not do well. Some industries are cyclical and companies need to be careful to manage the cyclicality to thrive in the long term. Product cycles get shorter as companies innovate and disrupt incumbents.
We need to choose what to hold very carefully.
Not all investments will increase in value with time.
A flawed assumption of buy and hold is that value of investments will increase with time. This is not true. Many companies can become uncompetitive, lose their relevance, management lose their direction and become dysfunctional. Only a small group of companies thrive and deliver outsized returns over time.
Time is the friend of the wonderful company, the enemy of the mediocre.Warren Buffett
In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.Ben Graham
In short term, the share price is heavily influenced by sentiment. In the long term, the share price will reflect its true value and potential. Time amplifies the quality of the companies which will translate to their share price performance.
It is not how long we hold that determines the stocks will go up; it is the quality of companies that we are convinced of their greatness and potential. Hence, we need to evaluate our stocks carefully and ensure that the stocks we hold have the potential to go up and/or the ability to give good dividend yields over the long term. Else, garbage in, garbage out.
Hold, not hope
Check your portfolio, poll your friends (if they are willing to share) and check with friends in the stockbroker industry on what most retail investors tend to hold. Most retail investors tend to hold losing poor-quality companies and had sold their winning high-quality companies early; turning supposedly short-term losing positions into long-term investments.
Selling your winners and holding your losers is like cutting the flowers and watering the weeds.Peter Lynch
What we hold should be the top conviction investments and winners that we believe will continue to reward us as we hold over time. Conversely, we should sell our losers to prevent them from losing their investment value further and move on with better investments.
Hold high-quality, cut poor-quality.
Unfortunately, some tend to do the opposite where they hold losing poor-quality companies hoping that they will recover and take profit on winning high-quality companies fast. As the saying goes: a bird in the hand is worth two in the bush — if you do not sell, you have not taken profits. They take profits fearing that the profits may go away.
It is easier to sell and book profits. Selling losing investments is “painful”. As the losses increase, they find it even harder to sell and they hold on. Cutting losses becomes more difficult and “painful”. The psychology is that when we sell the losing positions, the losses become realised and real. There is no “hope” to recoup the losses. By keeping holding to losing investments, it gives hope that one day, the losses will turn lesser and become profitable. Hope (rather than rationality) is the reason to hold these losing poor-quality investments. Over time, we become a hoarder of poor-quality investments like a bunch of lottery tickets.
The inability to cut losses is a big challenge for inexperienced retail investors. Money is struck and lost in value with poor-quality investments. The capital could have been redeployed for better opportunities. Losses are making us be less rational.
Make your portfolio reflect your best vision for our future.David Gardner, Motley Fool
The ability to cut loss is very important, especially with traders who trade on poor quality and speculative stocks. At times, when the trades do not go according to the trade plan, these losing trades become long-term investments as they do not practice stop-loss. They self-justify and flip-flop their strategy mid-way through the trade from short-term trading to longer-term investing. Slowly, more and more capital is “invested” in poor-quality investments.
Do not just hold and hope. Good returns do not just happen.
An investment with a poor quality uncompetitive company can easily rot especially during a challenging operating environment and lose value over time. We must have the rationality to evaluate and the strength to press the Sell button when need to.
Hold ≠ do nothing; hold = buy and continually verify.
Often, people think that “buy and hold” means holding patiently and doing nothing and abracadabra, it will gain with time.
No, we cannot assume that our investments will do well in the long term just by holding them. Some may gradually zig-zag their way up and some may zig-zag their way down. We need to know how well the companies will operate and adapt to the changing environment. Are they becoming more competitive and capturing greater value over time? Do not assume and trust; continually verify the investments we hold objectively:
- Is the investment still meeting our investing thesis?
- Do the investments still represent the best available investment option?
- Should we add more capital to these existing positions? If not, what are we doing about it?
- Are there any better investment opportunities that we can switch to?
A good litmus test will be: Will you add what you have been holding? If you have no positions, will you buy them now?
Holding investments should not be like some of our storeroom, garage, storage boxes and sometimes, shoe rack consisting of stuff we hardly (or never) used. We are wasting our capital that could be better utilised.
Do continuously validate what we invest and have the conviction of every stock we are holding that these stocks will reward us well in the long term.
Also, don’t keep watching the share prices. If we keep thinking about it unnecessarily, holding will be difficult and will consume our lives. Have a life, do other things and enjoy!
Holding quality stocks can be difficult.
Holding quality stocks to achieve multi-baggers is not easy as it looks on the price chart in hindsight; it can be difficult. As our stocks appreciate in value, we are afraid the unrealised gains will evaporate away if the stocks keep appreciating higher and higher. Many will be tempted to lock in gains of 50% let alone 100%, 200% or 1,000%. It can be difficult to hold if these investments keep appreciating in value and represent a higher percentage of our total portfolio and net worth. Yes, as the saying goes: a bird in the hand is worth two in the bush: realised profits count more than unrealised profits.
And as we hold, there will be market swings, pullbacks and crashes. Depending on what we invest, they can be drastic. Here are some examples:
In 20 years, Amazon is up almost 270 times. On annual basis, it can gain as much as 178% (2013) and lose as much as 45% (2008).
In 20 years, Microsoft gained almost 14 times. On annual basis, it can gain as much as 57% (2009) and lose as much as 45% (2008).
In 20 years, Walmart gained 2.5 times. On annual basis, it can gain as much as 42% (2017) and lose 28% (2015).
An example of a difficult holding situation would be a stock that you have been holding up 1,000% and have been slipping and crashing 30% (due to poor results, and external factors) thereafter can be very painful. Investors would start doubting these investments. In such instances, it is important to validate the investing thesis – is this a temporary blip or a fundamental weakening?
In short, this is what happens to successful companies and their stocks: the bigger the returns, expect greater the swings. Volatility is part of holding for the long term.
We need to have an investing strategy to guide us on what to do.
Unhold = admit mistakes, cut, learn and move on
There will always be mistakes made in investments. It is important to learn to cut, reflect, improve and move on. The ability to cut away mistakes is often an important trait of a good investor. It is more important for inexperienced investors and traders. More mistakes happen as we started out and we must know how to deal with mistakes. We cannot be holding on to our mistakes and thereby lock up precious capital for losing investments.
Even Warren Buffett makes mistakes. A recent mistake was IBM. In 2011, He bought about USD 10.8b worth of IBM through Berkshire Hathaway; 64 million shares at an average price of USD 170 each. By May 2018, Berkshire Hathaway no longer owned IBM stocks, the company had suffered nearly six years of declining revenue and a share price sinking into the mid-USD140 range. IBM was the first tech company he invested and during that period, he must be learning. In 2016, Buffett’s Berkshire Hathaway bought into Apple and was constantly adding that he switched out of IBM to Apple. As of 2021, he has more than quadrupled his money on Apple. Apple is by far the largest holding in Berkshire’s US stock portfolio, accounting for 43% of its total value of $293 billion at the end of September 2021. Apple is worth more than the next four biggest positions — Bank of America, American Express, Coca-Cola, and Kraft Heinz — combined.
Rule number 1: Never lose money.Warren Buffett
Rule number 2: Don’t forget rule number 1.
Do not hold poor-quality investments and let the money dwindle away unnecessarily. Holding poor investments can also add stress. We must have the strength to press the Sell button.
Mistakes offer some important lessons to learn. We are paying for mistakes with losses so do learn and not repeat the mistakes with more financial losses or high opportunity costs.
A related article: A very important skill that investors and traders must have
Hold ≠ never sell
The company is executing its strategy well and delivering good results. There will be periods where the financial market goes irrational exuberance and many are very optimistic and greedy; pushing valuation to a historical high. It is time to at least trim some to lock some gains. The financial market often swings between extreme greed and extreme fear that can be decoupled from business performance. It is a good opportunity to take advantage of such times to buy (when the market is in extreme fear) and sell (when the market is extreme greed).
Buy ≠ just buy once at any price
Buy does not mean buying a good company once and just holding. As we analyse and validate the quality of the company, we may add as it gets cheaper.
Buy and hold = f (investing strategy)
Buy and hold means differently to every investor. What stocks investors buy and hold, at what price they buy, how long they will hold and how they deal with poor quality investments are different. To traders especially day and leveraged traders, buy and hold can mean very different.
Investors have to decide how “buy and hold” fits their investment strategy which is about how we answer these 6 questions:
- What to buy?
- What price to buy?
- How much to buy?
- What to sell?
- What price to sell?
- How much to sell?
“Buy and hold” only makes sense as part of our broader investment strategy, else it is just a confusing phase.
Another related article: The great investing myth (1): Buy low, sell high