Why “buy and hold” strategy carries more risk?

Most of us hear the advice- “Buy XYZ stock and hold it for a long time”. These advices are more rampant when markets are down and the current stock prices are usually below your purchase price. This is because no “buy and hold” expert wants to acknowledge his/her mistake . So till the stock price gets above the recommended price, you can continue to increasing the holding period ( From 1 year to 3 years to 5 years to even 10 years). Some might even recommend to buy even more while the stock continues to fall! I don’t blame them-after all their job is to offer you some hope in bad times.

There are couple of things which I have observed for “buy and hold” investing. One thing which often gets quoted in favour of “buy and hold” is that it is not possible to time the market. Of course, I can’t pick tops and bottoms but one can’t surely pick a few uptrends and avoid a few downtrends.

Secondly-people often quote the famous Warren Buffet while advocating “buy and hold” strategy. Now can you be as patient as Warren Buffet in holding a stock like Coca Cola for last 10+ years without generating any significant returns. He holds Coca Cola for its “brand value”. Mr. Buffet can afford to “own a business”and influence the way it is run. Can an ordinary investor emulate that? How many “buy and hold” investors can stay on cash like Mr. Buffet did from 2004-2007 (during the great bull run) ?

I feel that “buy and hold” carries a lot more risk for a normal investor.

From the recent memory take a stock like JP associates. The stock went from 150 in June-July 2007 to 500+ in December 2007, only to fall back to 200 in January 2008.

If you consider a “buy and hold” investor who bought at 150, he would have made 30% on his investment but his drawdown from the top would have been 60%(risk). And those who bought at above 200-250 might have experienced a negative return.

Now lets take the case of picking a few trends. Even if a trader bought at 170 and sold at 400 or even 350 (not at the peak of 500), he/she would have made a return of more than 100% (in 6 months) while having a drawdown of just 20% from the peak (your risk). Doesn’t it offer a better risk/return profile?

Another advantage is that “buy and hold” guys never know when to cut their losses . They are so blinded by their hope and conviction that they sometimes miss the real picture. Take the JP associates example again. When do you think will the “buy and hold”investor bail out? Add to it the psychological pain of seeing such huge drawdowns (50-60% sometimes) in “buy and hold” strategy. It shakes your confidence and affects your mental ability to seek superior performance in the markets.

On the other hand, if you are trading the momentum you are always prepared to cut your losers(again not easy!) and get the best out of your winners.This results in better risk adjusted returns.

The only word of caution is that you don’t want to be over leveraged while trading trends. This is because one bad reversal can ruin your trading account!

“Buy and hold” is more about the future and I feel future is unknown. Do you know how stock markets shall look like in next 10 years? Would they still be generating 20% per annum returns or will the returns shrink to 5%? Is it a good idea to hold a stock for 10 years when you don’t know its future?

Many people ask me to recommend a stock they can hold for the next 10-20 years. Although I personally like a stock like Reliance which is in long term uptrend but I am not too sure if it shall stay that way for next 10 years. What if oil falls back to $30/barrel? Will Reliance stay at these elevated levels? What will a buy and hold investor do if Reliance stock reverses sharply in case of such scenarios?

Thats I why I feel uncomfortable giving such “buy and hold” recommendations. To me they appear more risky as it involves a lot of guess work.To me a simple”buy and hold” offers no real edge to the investor.

- SageCapital

well i didnt read the whole article, but i got the jist of it from the name some some lines.


Buy and hold strategy i agree may be a problem when a stock is going down and down but this strategy is mainly advised on

strong fundamental stocks for wealth creation (they increase over time and there is no actuall momentum) or

Possible multibaggers- these may be sometimes risky but only a buy and hold and turn your stocks into multibaggers.


To overcome the continous falling one should try and buy the stock at a reasonable price not when on the stock is on momentum and hope buy and hold would eventually pay and also there should be a time to time review of the company and if its performing fine, then eventually buy and hold would pay.

cheers

Good comments. But it does not convey your strategy - Do you have any alternative to this risky strategy of "Buy & Hold"

Lakshmanan

Thatz one way to view it, the other way is.

Consider this stock is fundamentally good and a good buy @ 170.

Trader buys the stock @ 170 and the goes down till 150, he cuts losses @ 155 but after touching 150 it bounces back to go to 400 or 350.

who is winner now ?

Also take the other case.... Stock started the journey from 150 to 170.

At 170 there is momentum so the trader buys, the momentum takes it to 220 and then there is correctiono so the trader books the profit @ 200. thats the realistic situation. So the momentum trader mostly never makes 100% return.

The author of the above article has misunderstood the concept. Buy and hold is not a trading strategy. It is merely identifying good businesses and buying them when the prices at which the shares are offered are reasonable and then not selling them. Now a problem arises if you measure the performance everyday. Buying and holding shares in a good business is like buying a house and not looking at daily property prices. It is about enjoying dividends for the long run. In the Warren Buffet example cited above the author states that Buffet has not benefited from Coca cola purchase. This is absolutely wrong. Buffet invested $1.299 Billions in coca cola and that portfolio is now worth some $12.274 Billion. This does not even take into account dividends paid by Coca Cola. People who buy and hold are not active traders but merely long-term investors. The only way they can invest in a business is in understanding the balance sheets and following the businesses of different companies. If one had invested in the Infosys Technologies public issue in 1993 and were alloted a market lot of shares that time then one would be worth about Rs. 1.25 crores by now not counting the dividends received on all the shares and bonus shares. Similiar such companies which gave long term returns are Colgate Palmolive, HUL, Wipro, Dr. Reddy's Labs etc. I have a buy and hold portfolio. I do not intend to sell for the next ten years. I did make few mistakes in buying some stocks at higher prices. However I do not check on the market to provide me a daily performance report of my shares. I expect to receive dividends of about Rs. 8000 this year. Take a look:

Ador Welding 210@163
Allahabad Bank 100@77
Andhra Bank 120@85
Aventis Pharma 5@1170
Bartronics 17@152
Bata India 80@145
Chemfab 200@100.10
Dr. Reddy 10@615
GSK Pharma 10@845
HUL 25@221
Hindalco 100@151
Indian Hotels 50@113
Raymond 40@315
Satyam 10@355
VST 101@324
Voltas 80@170
Wipro 10@442
Wyeth 50@465

With all due respect for the Buy and Hold investors,it only works for a very small percentage of the investing population. There is one and only one Warren Buffet, and comparing market returns to Warren Buffet's portfolio is like comparing Apples to Oranges. Warren Buffet buys businesses and has significant control over it- where as most of us don't.
There is an opportunity cost to holding a stock for ten years.It looks easy in the hindsight, same argument...if one had bought put options on dot com stocks in 2001 with all his money, ( or for that matter shorted NIFTY futures in Jan ) he would have retired in a year.

Buy and Hold works very well for me, it is the choosing the company to hold for long term which is very difficult. Some examples of buy and hold strategy-

Infosys - An investment of Rs. 10,000 in 1993 would be worth over Rs. 1.5 crores in 2008.

Unitech - An investment of Rs. 10,000 in 2003 would be worth over Rs. 1 crore in 2008.

Jaicorp - An investment of Rs. 10,000 in early 2006 would be worth over Rs. 22 lakhs in 2008.

And the Biggest of them-

Wipro - An investment of Rs. 10,000 in 1980 would be worth more than Rs.150 crore!!!! in 2008.

It is interesting that I ran across this thread today.
I finished reading Graham's book titled "the intelligent investor"

The idea as per the book is that you first find a stock that is selling below it's enterprise value, then you buy and hold.

And you buy and hold only till such time that it's stock price goes over it's enterprise value. This process make take several years, but the idea is that the stock price more often than not eventually catches up with the enterprise value.

So when it does go over the value you sell it and get good returns.

interestin stuffs here.

i remember in Kolkata meet Asish da said that trading can earn u income but only investments can make u wealthy

ha ha
i am still holding ipo maruti in demat
should get some credit
sounds odd as a member of traderji????????????