Buy-and-Hold Investing: 4 Ways to Make It More Effective

By Carlos Portocarrero on 9 February 2010 (Updated 23 February 2010) 5 comments

The buy-and-hold investing strategy is kind of like my dad's 1981 Toyota pickup truck: dependable, reliable, old, and a little raggedy looking. It's been around forever and everyone always takes it for granted.

But every time it breaks down, people tell him to dump it already. Enough with the 29-year old car already, they say.

Buy and hold investing just had a break down and everyone is rushing to claim it's no longer a valid investing strategy. If you read the news about investing, you'd think buy-and-hold was outdated, antiquated, and broken.

I do believe it needs a fresh coat of paint and maybe a new bumper, but the engine under the hood is still as sound as ever.

What the Media Says

Go to Google, type in "buy and hold dead" and you'll see what I'm talking about. Last year the stock market sucked and critics decided to run some analysis on how the S&P 500 did in the previous ten years. Here's what that would look like:

S&P 500 1999 to 2009
Courtesy of Yahoo! Finance

Now, most of these experts consider 10 years a really long time, which is kind of disingenuous. But what this "analysis" did was support the idea that buying a stock and holding it for a long period of time (10 years) no longer worked. Look at the data! It's over! Panic! Buy more papers and read our website!

To that I say: Paprikash!

Buy-and-hold still works, but if you're having trouble believing and want to try something to beef up your buy-and-hold investing, here are four ways to invest when you have a long-term view on a stock.

Moving Average

I read about this one over at MSN Money. The author of this story uses a 12-month moving average to determine whether it's time to buy into the stock or to sell out and put the money into something safe like bonds.

It's a pretty interesting concept since it doesn't involve a lot of buying and selling. Check out the S&P over that same period of time with the 12-month moving average line. The idea is to buy when the black line goes over the red line and sell when it goes under:

S&P Moving Average

According to the chart, you should've sold off your S&P stock right at the end of 2000, and not gotten back in until mid-2003. Look at the swoon you saved yourself from! Then you would've ridden the bull market all the way up to the beginning of 2008. Oh and that crash in late 2008? You would've been safe and sound.

That's ten years and only four moves (including one false alarm in 1999) — not bad at all.

Now, I'll be perfectly frank: I think technical analysis like this is kind of junky. I would never just buy and sell when a chart told me it was time.

But if you have a long-term interest in a stock this gives you an interesting way of skipping over the bad times and being in there for the good times.

Upside: Easy to follow, few transactions to pay fees on.

Downside: Taxes are a pain unless you're in a tax-protected account like a Roth, relying on a chart.

Value Averaging

I first heard about this strategy from Cash Money Life and I had to write about it myself. It's very similar to dollar-cost averaging, which is simply making regular investments over a period of time to smooth out the ups and downs of the market. It's a very safe, very conservative strategy.

What value averaging does is smarten up your traditional dollar-cost strategy. In my own words:

You want to have $5,000 invested at the end of the year so you invest the first $1,000, then wait until your next buying period. If the market goes up, you invest less. If the market goes down, you invest more. At the end of the year, you’ve invested the same $5,000 but you’ve made small changes as to when you put your money into the market. It’s classic buy low, sell high.

For more on this strategy, check out this paper that goes into a lot more detail.

Upside: Easy, simple, conservative.

Downside: Must pay attention to the market and decide when it's "high" or "low."

Take Your Money and Run

This is one I came up with in 2008 when things started to go really bad. I was still enamored with buy and sell, but wanted to find a way to avoid some of the pitfalls.

So I started to think like a trader: take your profits when you can get them and try to minimize the losing of money. One way of doing this is to set an artificial barrier — once you gain that amount you sell off and take some profits.

This may not sound like buy and hold anymore and I don't know how much of a fan I am of this concept anymore, but it's worth a look.

Say you decide 20% is your bar. If you gain 20% in a stock, you sell off some (or all) of it to reap the rewards. Then you have to decide when to get back in, which opens up a whole can of worms.

Upside: You'll never lose money if you don't sell at a loss.

Downside: When do you buy again? Artificial barrier is very unscientific.

Options

Trading options is not as complicated as you think. In fact, in many cases they are less risky than investing in stocks. And one way to use a long-term view on a stock with options is called a covered call.

This strategy is one of the most basic options moves out there, and it works like this: you own a stock and you sell calls on those stocks. What this means is you get some money from selling the calls and you will do better than just owning the stock if it:

  • Stays flat
  • Goes down

If the stock goes up beyond the strike price of your call, your stock is still going up but you did worse that just owning the stock. Still, two out of three ain't bad.

Check out Investopedia's Covered Call entry for more details on this strategy.

Upside: Very straightforward, protects you on two out of three outcomes.

Downside: Need to learn options, open an options-trading account.

Buy-and-Hold Is Here to Stay

There are a bunch of ways of making buy and hold more attractive, and these are just four of them. I especially like the idea of using the moving average strategy in a tax-protected account like a Roth IRA and owning dividend-yielding stocks.

This way you're not exposed to the huge drops, you get your dividend payments, and you don't pay any taxes on all the times you buy in and sell off.

The fundamental engine under buy and hold's hood seems to be as good as ever, although recent events have changed a lot of people's minds.

Do you still believe in buy-and-hold?

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Guest's picture

Just wanted to clarify one thing. The article states: "If the stock goes up beyond the strike price of your call, your stock is still going up but you did worse that just owning the stock."

It's only true if the stock goes up beyond the strike price plus the option sale price, since that option sale price is pure gain.

For example, buying stock at $50, and selling a $60 call for $5. If the stock goes up to $63, then you made $15 (10 on the stock and 5 on the option). This is still better than the $13 you would have made on the stock alone. If the stock goes up to $67, then you've got the situation where your $15 is less than the $17 you would have made without the covered call.

I do wholeheartedly agree that buy-and-hold definitely should include covered calls. Why would you settle for an average of 12% or so, when you can up that to 16% with hardly any effort at all?

Guest's picture
TheMightyQuinn

I think this may be the opposite of what you meant:
"The idea is to buy when the red line goes over the black line and sell when it goes under"

Carlos Portocarrero's picture

MightyQuinn: Thanks for catching that one, you're right! It's now fixed.

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Guest's picture
Christina

I am not a fan of the "Buy and Hold" strategy, while I know it worked for Warren Buffet, and possibly works for you, it has not worked for me at all.  I prefer penny stocks.  They can gain 300% to 500% in just a week if you invest correctly, and this means larger gains for me.  While the stock amount may be smaller, I do not care!  I am not risking as much, and I am making more for my penny =p.  I started profiting even more after I started taking the advice penny stock investors and brokers.  One really great penny stock newsletter I like is from www.hototc.com

Guest's picture
Büyü

Check out more of WC at The Writer's Coin, where he strives to become the Michael Lewis of personal finance.