The Myth of Buy and Hold

Up until recently, I saw a lot of personal investment advice that took the form of buy and hold, or in down markets buy more.  Individuals are constantly encouraged to create a savings and investment account and to buy at regular intervals.  Sometimes this was described as dollar-cost averaging.  Suggestions were usually of the form of having automatic payroll deductions that went into investment.  This is a great bull market strategy, and dollar-cost averaging (buying a fixed dollar amount each month) works out well if you are in a general upward trend in the marketplace.  The problem, is that 2008 was one of the worst years in history for stock markets.  Corporate bond and commodity markets didn’t do so well either, and January was also a difficult time.

In the midst of the hand-wringing, it’s time to investigate the buy and hold strategy.  Obviously, this is incorrect, the best strategy of course is to buy low and to sell high.  What I find interesting is that there is very little discussion of why Buy Low/Sell High is a very difficult strategy to implement.  In particular, when there is optimal pessimism in the overall market, that is probably the best opportunity to buy. Similarly, when there is an over abundance of optimism, that is a great time to sell.   Intuitively, I think many people recognize this, but trying to create an investment strategy that runs counter to one’s emotions is challenging.  Finally, there’s the issue of trying to implement a logical investment strategy for your own hard-earned money, which is different than having a detached view of what someone else should do.

Taking all of these issues into consideration, I would recommend the following steps to evaluate your strategy:

–Periodically correct your asset allocation (stocks, bonds, cash, commodities), say quarterly, if they drift substantially from where you invested them
–If you have a pattern of impulsive investments, shift more decisions to automatic investing or allocating
–Look at cash flow needs instead of net worth for determining investments
–Scrutinize the fee structure of investment products and question if a salesperson receives a substantial fee for something
–Finally, if you are diversified, do not look at your investment accounts too often, this feeds the pessimism and optimism cycle you are trying to counter.

see more Personal Finance musings this week at Dollar Frugal