Monday, September 14, 2009

What's Right with Buy-and-Hold?

So Buy-and-Hold has its flaws, but the alternative, which is trading is not much better. Empirically, trading has not help generated wealth. But before we come to some conclusion, let's look at the usual Pros with regard to Buy-and-Hold.

Pros

1. Missing out the 10 biggest days in positive movement

Studies have shown that if you subtract the returns of the 10 biggest positive gain days in the past 20 yrs, your long term average annual return drops something like from 8%pa to 4%pa. This is major bcos suddenly you might as well go and buy 30 Yr Singapore Govt bonds and that could have given you close to 4%pa, without all the risks associated with stock market. Since we cannot predict which days will be the biggest positive gain days in advance, value investors argue that we should always buy and hold to reap the full benefits.

2. Transaction cost

This has come down over the years but still constitute 0.5% or more to most retail investors. Considering in Singapore where the minimal brokerage cost is S$20 per trade, you need to do a S$8,000 trade so that you can get the buy and sell costs to be 0.5% of your trade. Sadly it can only go as low as 0.25% bcos after that, the brokers charge based on the size of your trade. So let's work with 0.5%. Most retail investors would probably do more than 1 buy-sell trade per year, let's say they do 2. We know that average annual market return is 8% and two trade incur transaction costs of 1%. Congrats, you just gave your brokers a 12% commission. Every year. So Buy-and-Hold pls, save the transaction cost.

3. Dividends

Globally dividend yield usually ranges from 2-4% and in extreme times, you see dividend yield of a market going to 6-7%, like the STI in 2008. Albeit it's a lagging yield bcos the data is always late to factor in a drop in dividend going forward. Anyhow, the point is, dividend is a huge part of return. Since we all know that average market return for investment is only 8%, dividends can constitute 25-50% of this market return. It does make sense to focus a lot on dividend stocks. And needless to say, to get dividends, you can't just trade, you need to buy-and-hold.

4. Missing out the full growth

This will be the most compelling argument. Trust me.

If you have bought a Great Company, not just Good but Great with a capital G, then there is never a right time to sell bcos the company simply grows exponentially and overwhelms everything! Some of Berkshire's companies would illustrate this very well. I will just highlight See's Candy and Coke. Buffett bought over the whole of See's Candy for USD 25mn in 1972. Today See's generate pre-tax earnings of over USD 1bn, if See's is a listed co. the market cap would be close to USD 20bn. So that's close to a 1,000 fold return. Mind you, that's 100,000% return. If you sold for 100% profit in 1973, you just made the biggest mistake of your life.

Coke tells the same story. Berkshire bought 8% of Coke for USD 1bn in 1988, today the same stake is worth USD 10bn and Coke's pre-tax earnings is USD 7bn, of which Berkshire is entitled USD 600mn (on paper). In another 10 yrs, the profits entitled to Berkshire would be more than what Berkshire paid for and this current ten bagger will become a 20 bagger or even more. So is there ever a right time to sell Coke?

Sadly, most retail investors never get to enjoy this kind of thrill bcos a 20% profit in 2 weeks is already better than sex.

Conclusion

Again in investing, there are no hard and fast rules, most of the time buy-and-hold makes sense, but there are times that they do not, some times you can take some profit here and there during those periods. However, to trade in and out every few weeks or days and try to beat buy-and-hold is a tall order. Much taller than most people would like to think so. Not to mention the effort needed to do those weekly trades! So run through the pros and cons again, when you are tempted to trade!

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