This guest post was written by Tony Chou at the Investorz’ Blog.
How many of you have heard of the buy and hold investment strategy? The basic theory is that the stock market moves in a general uptrend (and indeed it has, for the past 100 years). So instead of doing futile attempts at timing the market and making money off of short term fluctuations in the stock market, one should just ride the trend.
A well known practitioner of the buy and hold strategy is Warren Buffett, who frequently preaches this long term investment strategy. In fact, Warren’s right. Buy and hold certainly works for him, but probably not for the small guy. Here’s why.
The first part of buying and holding is simple. Anyone knows how to buy. But the second part is much harder. I ask you “can you hold?” Unless you have enough money to guarantee you that no matter what happens, you’ll still be able to live without working, buying and holding won’t work for you. Let’s assume a scenario. Joe buys Stock XYZ at $30. Then comes a big recession, the likes of which he’s never seen before. Now it times like this, Buffett would simply buy more stock, and hold onto whatever he’s already bought. But then what happens next shocks everyone. The recession gets worse and worse, and the stock market keeps falling. Stock XYZ has fallen to $18 a share. Because of the recession, Joe loses his job, and he can’t make ends meet at home. So now, he’s forced to sell all his stock in XYZ to cover his living expenses. After another few months, the economy brightens and the stock market bounces back. XYZ is now at $40 a share.
Most people in the middle class are like Joe. They have a decent job, but when they become unemployed, they are forced to turn to their savings to cover their cost of living. Joe was forced to sell at exactly the wrong time.
So this is what I say. “Anyone can buy, but can you hold?”