Connect with us

Investing

Stock investing strategies series: Does “Buy and Hold” actually work?

 

In part one of our stock investing strategies, we look at the dynamics of the popular “Buy and Hold” strategy and discuss the impact it can have on your investment portfolio.

In our previous article, we talk about some factors to consider when starting your 1st stock brokerage account. If you have already done so and are preparing to deep dive into stock investing, it is important to also understand some specific strategies. While there are many strategies available, it is only when one takes on investing with an open mind and learn to adapt to different economic situations can the person be successful in investing.

For today, we are going to discuss on the popular “Buy and Hold” strategy, which involves buying shares and holding it over long periods of time. This can be a period of 1 year to as long as 10 years. Do take note that we are focusing in on individual shares and not on index funds and that these insights are based on the writer’s observations and experiences.

Institutional Effect

When someone just started on his investing journey, the tendency to have the “Buy and Hold” mindset is very common. It is a simple strategy; once the investor is satisfied with his evaluation of the company, he buys in and holds the shares for a considerable amount of time, hoping to see the share price rise.

Note that, we used the word, “hoping”. Yes, an investor may be very confident about his evaluation of the company but one has to know that the market is driven by emotions and people react differently to macroeconomic situations. They perceive events differently; some overestimate the severity of the economic situation and sell their holdings, others underestimate the severity and see it as a buying opportunity to increase their holdings. This causes the share price to deviate from its intrinsic value. As retail investors, we also need to remember that we aren’t the only one in the marketplace. There are plenty of big institutional players such as investment funds that are consistently affecting the market as well.

The following is a case study charting the impact caused by institutional players.

 

On 23rd of May, ComfortDelgro Corp (Ticker: C52) dropped 12% in a single day. It turned out that the Singapore Labor Foundation liquidated 170 million shares in the company. What we can learn from this is that there are some events that we cannot possibly anticipate. After the 11% drop, did the stock go back up immediately? It didn’t, it continued to fall to $1.71, representing a further drop of 13%. It was due to the possible reversal of the Quantitative Easing program and this put downward pressure on all high-yielding investments including ComfortDelgro.

Economic Cycles

A “buy and hold” strategy does not always seem to work in all economic cycles. Let us look at a case study that is happening now. China, for the past decade has been averaging double-digit growth and it has emerged as the world’s second largest economy. When a country is growing at such rate, it has a very high consumption need. From copper, iron and steel to build skyscrapers to coal and oil to power up the country. Since then China has realized that it has been growing at the expense of the quality of the growth. It is now slowing down. And when it slows down, the world economy gets affected. From Brazil to Indonesia to Australia, these countries got hit hard because now, they export fewer resources to China. The companies operating in these segments have likewise been hit hard. Let us take a look:

Alcoa Inc. (Ticker: AA) is the world largest US-based company that produces Aluminum. Aluminum is a basic commodity that is needed to produce a wide variety of products from packaging cans to structural roofs.

Freeport Mcmoran (Ticker: FCX) is a US-based company that produces copper, which is needed for industrial purposes.

As seen in the graphs above, the shares of the companies got hit hard when there is a structural change going on in China. If an investor were to buy into these companies at a high price initially, he will be catching on the downtrend of the world commodity producers. How long would it take for these stocks to recover their losses and emerge as winning stock? Will the investor be prepared to wait out all the volatility in the stock? If the answer is yes, then the next question will be, “Can the investor deal with the opportunity cost of not allowing his money to be put to other good use?” This is an important question and it leads us to our next point.

 

Opportunity Cost

When the stock chart is down trending and an investor chooses not to liquidate his losing position, he is, effectively restricting himself to other opportunities available in the market. That is because his funds are tied up in this down trending stock. When an investor buys into a stock, he should already have some expectations on the share performance and for how long he is willing to hold them for. If an investor buys and holds shares, expecting it to perform but it failed to do so, he is just hogging onto funds, which could be directed to other better investment.

Shares, unlike index funds are succumbed to specific business risks and these risks are un-diversifiable. While an investor is holding on to shares, it is important for him/her to consider broad-based events that might affect not only the macro-economic environment but also isolated events that will affect the value of the shares. In our opinion, the opportunity cost is too much for an investor to bear. The sensible investor has to take on an active approach when investing in company-specific shares.

We hope this article managed to provide you with fresh perspectives on the “Buy and Hold” strategy. We will discuss another strategy next week, which is the “Buy High, Sell Higher” strategy. Do follow us on Facebook if you like to stay in touch with our articles and be exposed to more financial related articles.