Tuesday, June 30, 2009

How to build wealth using a buy and hold strategy

The investment gurus have all advised investors to follow a buy and hold strategy to build long term wealth. Investors, fund managers, academics like Warren Buffett, John Bogle, Jeremy Siegel, Phil Fisher, Peter Lynch have provided us with their tried and tested methods.

Yet, whenever a bear attack makes the market trajectory go haywire (i.e. in any direction but up!) all kinds of 'new' theories start to appear and re-appear. Fundamentals and technicals are all hogwash. It is all about sentiment and momentum. It is a traders' market. Buy and hold is dead.

The last named theory has been bandied about quite a bit of late. Probably by those unfortunate folks who got all excited by an ever-rising bull market and got in pretty much near the very top. I have been there and done that, and lost a pile of money.

But that didn't make me go out and search for a new theory. It taught me that to make money in the stock market, you can't jump in feet first without any inkling about what the market is all about, and how some companies make real profits in a sector while many do not.

You've got to pay your dues. By losing money, and by spending the time and effort to learn how to analyse a company by studying the Annual Report in detail AND how to look at technical charts to analyse the supply-demand mismatch in the market.

You can pick the best company and buy it near the market top, and you may not make any money for years. You buy the same company near a market bottom and sell it when it gains 25% or 50%, and you can miss a multibagger.

However unexciting and boring it may sound, investment is serious business. It requires patience, perseverance and discipline - not only to build serious wealth, but to keep it from disappearing.

There lies the main problem with trading. You make money fast, and you lose it faster. The odds are better in a casino. After you pay the brokerage and your taxes, you may find that you would have been better off keeping the money in a savings bank.

Strong, well-managed companies have various ways of rewarding their shareholders. A bonus this year; a rights 3 years later; regular dividends; share buy-backs. After a few years you find that your 100 shares have become 350, plus the market value has tripled. There is one condition. You have to stay the course. Flitting in and out of stocks will only make your broker rich.

Take the example of ICI Ltd. A staid paints stock that was going abegging at Rs 85 in 2002. In the seven years since, it has paid a total dividend of Rs 85 per share. No bonus. No rights. A share buy-back last year, and the stock is at Rs 500! I'm still holding.

What do you think, dear reader? Do you feel the buy and hold strategy may be the way to long term wealth? If not, why not?

Related posts

About portfolio suggestions and a stock not to be picked
Investment Philosophy of an Experienced Investor


Unknown said...

1) The most important thing, as you point out is to buy at the right price.

2) The ability to hold the stock through market cycles. This would not be possible without [1].

3) Buy and Hold <> Buy and Forget. Most good companies do not need a regular check every month. But, annual evaluation along with keeping track of the news flow could be better.

4) This ridiculing of value investing and buy and hold is a typical bear market phenomenon (though I am only in my first bear market ;-)). It's normal human behaviour to look at a short term record and project them into long term.

Venky said...

Nice Writeup. Buy and hold is a good strategy to follow, but not sacrosanct. Before you think that I am in the league of traders, let me state this. I personally think only 1% of the entire trade junta ever makes money consistently (I am not a trader). Its just not everoyone's cup of tea. So one should get into it with great caution. The idea behind value investing is, identify companies that are selling at significant discount to market prices and sell them when they start to reflect the fully priced status, as decided by your individual analysis. From whatever little I have read, there are different facets to value investing. The categories maybe buy & hold forever (like Warren Buffett), buy underpriced & sell when fully priced (like Seth Klarman etc.). One should follow what is suitable to one's investment temparament. So I think buy and hold is just one face of VI and there are others too. But other than that I would agree with your entire article that in times like these, people tipple heavily & drive without thinking about the consequences. Accidents wil and have to occur.


Subhankar said...

@Eswar: Yes Eswar. Buying at the 'right' price and holding for the long term is conducive to wealth building.

But don't forget that you only make money if you sell. Partial profit booking and moving the cash to fixed income instruments is an important part of wealth building.

@Venky: Thanks Venky. One of my favourite quotes is: Discussion leads to education. I'll be the first to admit that there is no one-size-fits-all strategy in investing. Every one should follow a strategy that works.

My motivation in writing such posts is to shorten the learning curve of my readers.

SG Money Mind said...

Buy and hold is the last step of the investment. But people forget that there are so many steps before that which compounds the problems. If you did a buy and hold of companies like BPL you will be nowhere.

SUJAI said...

Educative and interesting article. Booking profit and moving it into fixed instrument needs great discipline.

Subhankar said...

@SGMM: You're quite correct. Buy and hold comes after the stock picking exercise is completed.

I have written a three part series on stock picking. Part I covered how to choose sectors; Part II discussed the top-down approach; Part III was about the bottom-up method.

@Sujai: Thanks. Discipline is an important trait for wealth building.

Salting some money away during bull markets and redeploying in bear markets isn't easy - but is a recipe for investment success.

br8star said...

Nicely written article...thanks!
I think there are two clear camps: investors (buy and hold) and traders (buy-sell-buy-sell-...). I'd imagine that most people are investors than traders, just because being a trader requires more knowledge, patience, discipline and time...not everyone is willing to invest in these things :-).

But with easy access to news and knowledge these days and a willingness to ride it all, I want to wear both the above hats now :-). There are a few stocks/MF's which I have been holding for very long and seen them appreciate just as you described. And there are many more which I bought with the investor hat on and am licking my wounds now. Yes, I paid the dues and I don't want to any more ;-). So, while I stay long (very long)on a few, there are some I want to trade...keeping the two hats on...an "investing trader"?

Subhankar said...

Appreciate your comments, br8star.

Every investor should follow a strategy that evolves and works. No strategy is fool-proof. Making mistakes and losing money is part and parcel of investing in the stock markets.

I avoid day-trading because of the risks and the poor odds. But longer term trading is an important aspect of investment success. Specially if you own cyclicals and FMCG stocks.

In my post on IFCI Ltd, I have written about a 90-10 strategy that I follow.