Why Buffett's Buy-And-Hold Strategy Is Losing Its Appeal

By Marc Davis | June 28, 2011 AAA
Why Buffett's Buy-And-Hold Strategy Is Losing Its Appeal

As an investment strategy, the buy-and-hold approach to the stock market has long been the consensus among professional financial advisers. But does Buffett's preferred method of investing still hold up to today's markets?

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Historical Data
According to stock market performance data, holding equities over a 20-year period yields profits, despite up and down market cycles. Holding stocks for shorter periods, even for ten years, may not produce a profit if stocks are sold at the end of that decade if the market is down.

The maximum average market return over 20 years, however, was 14.4%, and the minimum 2.4%, still well above current returns on short- to mid-term U.S. Treasuries and Triple-A corporate bonds.

Despite the stock market's history of steady increases over the decades, since the 2008 beginning of the recession when stock prices fell, many - but not all - financial advisers have been recommending that a percentage of an investment portfolio of stocks be more actively managed. Active management means looking for potentially profitable buying and selling opportunities in a currently volatile market, and trading accordingly. (To find an investment strategy that lines up with your investment need and risk profile, check out Buy-And-Hold Investing Vs. Market Timing.)

Predicting Stock Movement
Two basic indicators suggest (but not always reliably) which stocks may be due to rise or fall. First, technical data reflected in stock charts which visually track recent price performance can reveal an upward or downward trend and where the price ceiling or price floor has been recently established. The charts can suggest where the next price breakthrough may occur, either at the top or bottom of the trading range, or if the price will "bounce" off the ceiling or floor. (Interview with financial adviser, knowledge of economics.)

The second indicator of a potential buy or sell is a company's fundamentals - analysis of its balance sheet, assets v. liabilities, quarterly profitability forecasts, cash flow, new product rollouts, innovation, new patents acquired, changes in senior management, and similar information.

Brokerage firms such as Ameritrade Holding, E*Trade Financial and Charles Schwab have confirmed that investors are now buying and selling at a higher volume than previously. Increased trading indicates more active management of investment portfolios and that a larger percentage of those portfolios consist of recently acquired equities and that equities previously held have been liquidated. (For more indicator that you can use, read 4 Key Indicators That Move The Markets.)

Investing in the New Economy
The new investors' philosophy seems to be, rather than pay a financial adviser to let their stocks languish in a buy-and-hold paralysis as the market falls, a potentially more profitable move is to pay advisers to protect and increase a portfolio's bottom line by actively trading.

A perfect example of the vulnerability of the buy-and-hold strategy is the technology stock boom followed by the tech stock bust. Tech stocks in general soared in price during the bull market of the late 1990s. Sun Microsystems whihc is now owned by Oracle Corporation (Nasdaq:ORCL), made software and Internet hardware for a burgeoning World Wide Web. All indicators, technical and fundamental both, pointed toward continued growth and profitability of the company.

Yet despite Sun Microsystems' bright prospects, other tech firms were moving up fast to challenge Sun Micro's market dominance. The stock fell in the face of competition from IBM (NYSE:IBM) and Hewlett Packard (NYSE:HPQ), and other tech competitors and its price has declined some 85% since its high. Obviously, Buy-And-Hold would not have worked in this instance, and there are numerous other examples of once-high-flying equities which have fallen on hard times and low stock prices.

As a result of such steep market reversals, and in the wake of generally declining markets, despite recent run-ups, more financial advisers are giving up on buy-and-hold as a way to manage retirement portfolios, according to a poll of advisers conducted by consulting firms GDC Research LLC of Sherborn, Mass., and Practical Perspectives LLC of Boxford, Mass, according to the Wall Street Journal. Of 500 financial advisers polled, some 21% have adopted opportunistic trading strategies, and the trend seems to be growing. (For more information on what strategies to use, see Brokers: Tips For When To Buy, Sell Or Hold.)

The Bottom Line
Still, many veteran financial advisers still recommend the buy-and-hold strategy because of its tax efficiency, it's relatively stress-free status, and because history has shown that long-term, the market goes up. Yet, keep in mind what these same financial advisers are required to tell their clients: Past performance is no guarantee of future performance. (To learn more about portfolio management, read Portfolio Management Pays Off In A Tough Market.)

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