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Why Buy & Hold Works and Trading Doesn’t

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Stock Market ReturnsBuying and selling stocks, like buying or selling anything, is fun. Buying and holding is not fun. Buying and holding for forty years is not only not fun, it’s boring. But, like broccoli and wearing your seat belt, boring is oftentimes good for you and in the case of your financial health, it’s very good for you.

The path to financial success is being able to make the right bets at the right time. For most of us, we have neither the funds nor the energy to study the markets well enough to make the right bets at the right time. Think back to any war story your friends ever told you about their trip to the casino. For every one tall tale of success, there are dozens untold stories.

I’ll give you an example. The most I’ve ever won in a casino was on a cruise ship a few years ago at the craps table. Craps is a lot of fun because it’s social in nature. After maybe an hour, I was up somewhere close to a thousand dollars. I walked away with the money in my pocket because, and this is one of the benefits of craps, we wanted to do something else and it’s hard to stand there for an hour. That’s a great story… except behind it are a bunch of stories where I sat down at a three card poker table and lost $200 in about 10 minutes. Or $100 in about 15 minutes at roulette.

The reality is that trading stocks frequently is a losing game and for every Apple success story (I bought shares at $90 and sold them at $560), there are a million other BPs and the like. We aren’t good enough at trading and here why:

You Have a Job

One of the hardest things about investing is that you have very little control over how much your investment make or lose. You control two things – 1) when you buy and 2) when you sell. This is in direct contrast to almost everything else in your life, including what typically is your number one source of income: your job.

If you have a job, chances are you have to do it on a daily basis and that means you can’t be watching the stock market when it’s open at 9:30am and when it closes at 4:00pm. You can’t be reading news all day, you can’t be studying charts, and you can’t be watching all the other things you need to in order to successfully “trade.”

You Have Emotions

The largest percentage gain by the Dow in the modern era (well, after 1935 anyway) were both in October 2008 when it popped 11.08% on the 13th and 10.88% on the 28th. Those are atypical, obviously, but these swings were close to a 7.87% loss on 10/15/2008 and a 7.33% loss on 10/09/2008. As you may recall, Lehman Brothers filed Chapter 11 on 9/15/2008 and the markets were a mess for a short period afterwards.

If you were invested in 2008, did you panic and pull your money? If you panicked, what are the chances you put your money back in just a few days later? 10/9/08 the market tanks 7.33% only to jump back up by 11.08% on 10/13/08.

Which leads to the next point…

You’re Not a Machine

You are not dispassionate like a machine. You’re not fast like a machine. You don’t have set rules like a machine. You cannot trade like a machine and a machine will eat you up. High frequency trading algorithms are eating your lunch right now and make up the bulk of the transactions today.

Would you play a machine at chess for money?

You Don’t Have Enough Invested

How much do you have invested in the stock market right now? $10,000 is a lot of money in the real world, it’s nothing in the stock market. How much of a return do you need to make to cover transaction costs? If you use a discount broker and pay $5 a trade, you need at least a tenth of a percent of gain to offset the round trip transaction cost of buying and selling.

So now your bar is to exceed a single percent… let’s say you buy a stock and it goes up 10%. 10% is pretty good… that’s $1,000 on a $10,000 investment. You sell it and shave off that tenth of a percent to cover costs, you’re at $990. Now you pay short term capital gains (you’re in the 25% tax bracket), so you end up with $742.50 on a $10,000 investment. 7.42% isn’t bad… but was it worth all your time tracking? Can you repeat it?

I suspect not.

The reality is that investing for most of us should not be exciting. It should be boring so you don’t get tempted to do something stupid like chase an IPO (Facebook anyone?) or some other high flyer. Be excited by the other things in life and if you want to gamble, go to a casino… at least they’ll give you free drinks. :)

(Photo Credit: SalFalko)

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6 Responses to “Why Buy & Hold Works and Trading Doesn’t”

  1. I agree that trading is a loser’s game. Not sure I agree that buy & hold is the way to go, however. Might there be a third way that doesn’t require putting our retirement comfort at the mercy of the Wall Street’s shenanigans and stock price extreme volatility?

    • Buy and hold doesn’t necessarily mean stocks. It can — and should — just as easily apply to, say, high-quality short-to-intermediate-term bonds, which aren’t nearly as volatile but are *expected* to have lower returns over the long term.

  2. Ron C says:

    As I slide toward the down side of life, I reflect on my financial investment decisions, the private real estate development oompany where they put the shingles on the apartment backwards, when I sold Amazon, a flyer at the time, for single digit dollars. Those were a few of my diversified portfolio efforts. For me now, it’s buy into the big companies (United Technologies) utx, oil, some food like Kraft, Pepsi, Coke (food?), McDonald’s, Real estate Investment companies, some aerospace and defense (they have lots of lobbyists), etc. All have some dividend base. I’ve figured in five years into the future I will not have lost much money. Maybe I’ll be even, and maybe make some. Right after I buy any stock, the price drops, so do not follow my picks. I use an online investment company and pay $7.95 for each purchase. I also have an account with a local investment adviser who’s picks are always worse than throwing darts at the financial section of a newspaper. Bottom line I don’t have the capability or interest to read the financial times, the WSJ, etc. I know my investment decisions are like the flea on the end of a dog’s tail. Such a small bite that it is not felt. But I’ve been modestly successful. Just stay away from IPO’s and high flyers. They will bite you in the end.

  3. Derrick says:

    I’m not sure I get the point of your article. You say buy and hold works but for every apple there is a BP. Wouldn’t that imply it doesn’t work? Buy and hold worked in the past but If you look at the past 10 years the makets didn’t even beat inflation. Look at he Nasdaq from 2000- I doubt it gets to the top in a very long time. Yes- all trading doesn’t work for everyone but if you focus on managing your risk and playing the probability game tub have a better shot at beating the averages.

  4. admiral58 says:

    It’s very hard to time the market. And taxes always play a huge impact.

  5. Scott says:

    I agree that investing shouldn’t be exciting – if it is you’re probably doing something wrong.

    I’ve been investing in ETFs for quite awhile now for the instant diversification, but I still have a few stocks purchased years ago. One is NAT, which I bought at $27 and is now trading for about $9. Keeping the stock serves a purpose: Whenever I think about buying an individual stock, I look at that one and tell myself I’m not a stock picker.


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