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Stock Ideas Investors Daily Edge Buy and Hold equates to Buy and Hope
Stock Ideas Investors Daily Edge Buy and Hold equates to Buy and Hope 
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| Buy and Hold equates to Buy and Hope |
| Wednesday, 04 February 2009 | ||||||||
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One of the most common bits of advice passed on to investors is “buy and hold”. Championed by investment king Warren Buffett, it is often pointed to as the best strategy to long-term wealth. Except it is just the opposite. It is probably the fastest way to see your money evaporate and let profits slip through your fingers. There are some flaws with this strategy that many investors fail to notice. The first problem with a ‘buy and hold’ strategy is that it isn’t a strategy. It is more like “buy and hope” that the stock will always go up. Since there is no planned exit point, the risk is enormous with this investment method. Let’s look at Google as an example. Let’s say you bought GOOG back around April of 2006 (denoted by the red arrow on the chart). You would have gotten in somewhere around $350/share. By the end of 2007, the stock was trading around $700/share. Your investment would have returned a fantastic 100 percent. Following the ‘buy and hold’ method, you would now be sitting on a minimal gain, if any. After peaking around $720/share, GOOG slid all the way back down to $275/share late last year. You would have seen your 100 percent gain evaporate, and actually see a loss on your investment until a recent rally that brought the share price back up. What sense does that make? Why let a 100 percent gain disappear? The obvious answer is it doesn’t make sense, and that is the flaw with ‘buy and hold’ investing. Without planned exit points, you can see tremendous gains disappear. Who knows how long it could take GOOG to make it back over $700/ share, if ever. And that is just an example of a tremendous gain that slipped away. What if you never make it to positive territory? Let’s look at AIG, the embattled insurer.
Had you bought AIG December of 2006, you would have gotten in around $72/share. The current price? Around $1.25/share. That’s a loss of 98 percent. Again, buy and hold results in a terrible loss that could have been avoided. Both of these examples show flaws with buying stocks and holding them without any exit strategy. Profits are lost, and huge losses aren’t cut. To remedy this problem, you always need to have a plan before entering a trade. That way, you can measure your risk, and determine if the trade makes sense for you. It also helps to have preset points that you will take profits. I like to use pre-set profit points (such as 25%, 50%, or 100%) as well as trailing stops and stop-loss points. For example on the Google trade, you could have gone into the trade with the following exit points: take half the trade off the table at a 50% gain and close the remainder if the stock falls 10 percent from its high. You would have closed half your position at $525.share, and closed the last half when GOOG fell to $650/share. Overall, your gain would have been 67.8 percent. Compare that to the 0 percent profit on the buy and hold strategy. The AIG trade needed a stop-loss point to minimize a devastating loss. Had you entered the trade with a stop-loss point of 15-20 percent, you would have been out of the trade when AIG fell from $72/share to $57.60/share. Sure, a 20 percent loss hurts, but you can come back and fight another day. Taking a 98 percent loss because you didn’t have proper risk management is absolutely crushing. You could lose all your capital in one trade. Just make sure that even if you are long-term investor, that you still properly minimize risk by defining your exit plans on all your trades. Nothing is worse for your portfolio than not capturing gains or letting losses run. Make your voice heard -- to let us know your thoughts on this article, you can click here and leave your comments for the IDE community as well as the editors.
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