Friday, September 04, 2009

What's Wrong with Buy-and-Hold?

This is another topic that has been debated left-right-centre since... Geez, Adam and Eve I guess. Let's just go through the usual pros and cons. I will start with the Cons.

Cons

1. Doesn't help to make money

This has been highlighted various times in the papers. Someone who bought an index, say the S&P500 and held for the past 10 years would have made zero return. In some markets, you could have bought-and-hold for the last 20 years and still lost money. The best example being Japan. Buy-and-hold at any point over the past 20 years would have made negative return! So to hell with Buy-and-Hold right?

2. What about locking in profits?

If a stock has risen 100%, and knowing that stocks on average gives only 8%pa, this stock has already given you roughly 10 yrs worth of return, isn't it a good idea to lock in the profits? Especially if the stock intrinsic value is not going to grow by that much over time - meaning that it's grossly overvalued. We should sell when things are grossly overvalued, right?

3. There is no time.

Buy-and-hold takes a long time to give you a good return ie average market return of 8%pa. However, time is a luxury that not everyone has, especially if you are 40 and above. You need a substantial retirement nest egg in 15 yrs assuming you retire at 55. Although retirement age is 62, most people don't get to stay employed until that age unless you are a civil servant, or self-employed. And increasingly, the career lifespan is shortening, look around you, do you see a lot of your colleagues in their 50s? So how do you buy-and-hold in 10 or 15 years? Incidentally, if you bought the STI index in Dec 99 at 2,600 points, you just managed to claw back your capital as the STI today is, well, at 2,600 points! 0%pa after 10 years, that's great isn't it?

So Buy-and-Hold sucks, what should we do?

Well you trade. You buy the STI when it was at 1,200 in Sep 2000, Hold until Sep 2007 and sell at the peak of more than 3,000. Buy back when it dropped to a low at 1,500 in Jan 2009 and sell now at 2,600. You would have make 500% gain over the past 10 yrs, that's roughly 50%pa.

Haha, well this can only be done on hindsight. Most traders lose their pants trading bcos their emotions get to them. Even if they bought at 1,200, they would have sold when it reached 2,000. Then hastily buy more when it reaches 3,000 and then got stuck when it collapsed, etc. Well you know the story, don't you.

Trading works when you have a good trading system and you adhere to it. 100%. If you do that, you can probably make an average return of 4-6%pa after transaction cost. Of course, legendary traders make a lot more than a meagre 4-6%pa. So we should strive to be like them! Then value investors will bring out Warren Buffett, who made 24%pa for 50 yrs and grew USD 1mn to USD 60 BILLON. So better argue based on average returns, not the legends' rate of returns.

In reality, most retail traders lose money trading. We are not even talking about market return of 8%pa here. Next post, we look at what's right with Buy-and-Hold.
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