I could not be prouder: In two weeks, my daughter will graduate from the University of Alabama as one of the top finance students in her class.
Now, in one of her advanced classes this year, her professor discussed the “Buy and Hold” strategy employed by many investors. And if you’ve read my Money and Markets columns over the past couple weeks, you know I’m not a fan of this strategy. In fact, I think “Buy and Hold” is only worth considering if you’re planning to hold your shares for 40 years, and you won’t need to touch any of your capital during that time.
My daughter, of course, has been around me long enough to know my views on the strategy. And by studying the markets on her own, she has come to hold the same beliefs. She asked her professor if he invests his own money using a Buy and Hold strategy. And when he didn’t answer, she told her classmates about Trend Following.
To understand the relative effectiveness of this method of investing, just consider that if you had bought and held certain stocks in the heady days of the 1990s, you could have lost 80 percent or more when the dot-com bubble burst in the early 2000s.
Why Doesn’t “Buy and Hold” Work?
This is an interesting question. After all, shouldn’t stock prices be based on the underlying fundamentals of the companies? And aren’t many of those companies in good financial health?
Well, yes and no. Yes, stock price is partially based on fundamentals. But it’s also influenced heavily by human nature. And the two emotions that play the largest role in determining the movements of individual stocks, and the overall market, are Fear and Greed.
Fear causes investors to sell out of their positions during tough times. For example, I began my career as a stockbroker in the mid-1970s, when the economy was trying to dig out from the bear market of 1973-74. And many people I talked to during that time told me they’d never buy another stock again.
On the other hand, Greed causes investors to jump on the bandwagon when times are good. A perfect example was the 1980s, when many of my colleagues, and many individual investors, bought undervalued stocks, and waited for them to rise in value. In some cases, the strategy worked — at least for a while.
But even when this “Buy and Hold” strategy does work, the returns it provides pale in comparison with a simple Trend Following strategy. And of course, “Buy and Hold” provides no roadmap for profiting when the market inevitably turns sour again.
How to Profit in Both Up and Down Markets
There are several disadvantages to using a Buy and Hold strategy. For one, the markets never move in a straight line. Look at any chart for any asset and you’ll find that it tends to move in trends that may last several months or even years. A good example is gold, which many investors thought would continue to move inexorably higher. They were under the impression that they simply had to buy and hold the precious metal to profit handsomely. As we’ve seen over the past couple weeks, that argument was fatally flawed.
Another reason to eschew a Buy and Hold strategy is because no one — not even the most successful stock picker — can consistently predict the movements of the markets. But if we understand that those movements are often based on the emotions of Fear and Greed, it can give us an edge over other investors.
|Trend Following can help you avoid the fear and greed emotions that plague many investors.|
If you study the markets for long enough, as I have, you’ll notice that many investors buy near the top of the market, because they think that prices will keep rising (this was the case with gold recently). By the same token, many investors sell near the bottom of the market, because they think prices will keep falling.
But by using a Trend Following strategy, you can avoid these pitfalls.
My All-Weather Investor and Inflation Survival Strategy investment services employ a trading model that I developed with my mentor, Sir John Templeton. The model doesn’t try to predict where the markets are going, or use fundamental analysis to find undervalued assets. Instead, it takes advantage of market trends created by investors buying into rallies and selling into declines.
I’ve found that it is only by recognizing this common mistake, and using it to our advantage, that we can consistently profit from both rising and falling markets.