The All-American Buy-and-Hold Strategy

Stock investors are urged by Wall Street and the financial press all the time to buy good stocks and hold them for the intermediate to long term in the expectation that the stocks will appreciate in value - and price. If they are right, and sometimes they are, investors reap the benefits and create wealth. So at least goes the theory.

I have some fundamental problems with the buy-and-hold (B&H) strategy:

1. Stocks don't always go up.
A lot of people (everyone's Aunt Mabel, for instance) tend to buy stocks at the end of a bull market, after listening to feverish stock market stories for years, only to later watch them fall for years through a bear market. The B&H proponents say not to worry when the market turns down; just hold onto those stocks, because market dips are transient things. Well, transient is as transient does…

The market last century went up an average of 9% a year approximately. But that is an average. There have been long periods when stocks underperformed risk-free rates of return, and when stocks even turned in negative returns. The prices of stocks bought in 1929 before the great crash in general did not recover their prices until 1953, almost a quarter of a century later. It took over 20 years after 1966 for the market to make gains. And there have been lesser periods of 10 or more years when stocks performed very poorly. Most investors don't have a lot of cash to invest when young and do the majority of their investing during middle age, thus a lengthy underperforming market burns up time they don't have.

2. It Ain't Just the Fundamentals.
Picking stocks that will appreciate is tough. The B&H investor is looking for great fundamentals - a company that will grow its business and profits over the years. You could, alternatively, pick a great company that is out of favor and undervalued on the assumption the stock has to go up, but it could be years before the stock moves, if ever. There are many vagaries that affect long-term success, such as changes in technology and markets, some unknown and unforeseeable even by the people in an industry being affected. Just buying stocks early in a bull market is no guarantee of appreciation, either. Who was the major search engine company before Google came along? Right, I can't remember it, either. B&H is a gamble, no matter how you look at it. Yes, stock picking can work, but consider the next two points…

3. Buy and Hold Does Not Produce Income.
B&H produces no cash flow except for dividends, assuming the stock pays dividends. Growth stocks, the ones most likely to be your home run, usually don't. Any mogul, like Trump and Buffett, will tell you it's all about cash flow - yours! If your investments aren't producing cash flow, you're being fleeced, once you consider the opportunity cost. When income is not being produced, you literally are hoping that the stocks increase enough over time to get the economic job done.

4. Buy-and-Hold Ties Up Capital.
If you need money to send kids to college, or whatever, the B&H strategy's lack of cash flow means that you have to sell stock in order to pull cash out of your assets. If the stocks are up at the point that you need cash, wonderful simply sell some shares and use the taxable gain as you wish. But what if the stocks are flat, or down? In that case you are digging into your capital, perhaps taking a loss, in order to get your hands on some cash. This, obviously, is not a good practice. And it is all because the stocks are not producing income.

5. Value Investing: Whose Value?
Wall Street touts B&H as value investing, but picking the companies with the greatest "value" is no sure road to riches. First of all, stock price doesn't necessarily bear any relation to value, now or in the future. Second, no two people, even experts, can very often agree which companies represent the greatest "value" even in the same industry. If you select an investment based on its inherent value, whose value are you using? Perceptions of value rule, not value itself. Studies don't show much of a correlation between value and return, and the best returns come from hot-shot stocks.

6. Wall Street Doesn't Do It.
Wall Street preaches the B&H strategy, but Wall Street doesn't buy stocks and hold them! WS firms are traders. And the large Wall Street firms seem to do quite well trading, since so few of the big ones go out of business, which is what they say happens to traders. Odd that they would tout a strategy they themselves don't employ. Ah, well, Wall Street firms need buyers for stocks, so touting the B&H strategy makes dollars and sense for them. Think about that one the next time a Wall Street firm or some financial pundit tells you that buy-and-hold is the only strategy that works over the long haul. For one thing, it isn't. For another, B&h by no means works for everyone.

7. How Much Time Do You Have Left?
This is a trick question, of course, since none of us knows the answer. But since B&H is truly a long-term strategy that can produce wealth only over the long term, assuming it does actually produce wealth, it is a question you realistically must ask of yourself, even though the answer is purely a statistical one: how much time have you got left? And do you have time for B&H to work?

If you are 35, you probably have a lot of time left, at least statistically but perhaps not a lot of money to invest. If 55, you have not quite so much time, but a good 20 years of more in all likelihood; you probably have more money, though. If 65 to 70, you likely have the most money but time is, well, growing shorter.

Sure, picking the really great companies makes more sense than most other B&H strategies, but how the stock will perform is not foreseeable, even if the company itself does wonderfully; don't kid yourself. And even if you pick the "right" stocks, it may take years to see real price improvement while your cash is tied up, making no return for you.

Cut it how you will, the classic B&H strategy is a "buy and hope" strategy. B&H is a passive strategy that relies on market forces to do the work of increasing your portfolio's value. That, indeed, is it's allure - let the market do the work. Can't pick the right stocks? Well don't despair, because Wall Street, Motley Fool and, heck, almost everybody, knows just which stocks you should buy. The same people who will tell you it is not possible to consistently pick winning stocks for covered call writing (but it is quite possible) will in their next breath tell you that consistent investing success comes only from picking stocks that will win - gain in value - over years!!

While Wall Street and most financial pundits deride trading as speculation, B&Hitself is speculation just as surely as trading, just of a more passive kind. But stock picking is stock picking, folks. As Larry McMillan puts it so elegantly, making a profit in the market requires that you predict something, since only professional traders with no trade costs can profit off razor-thin arbitrage activities. Selecting stocks for B&H is predicting something - isn't it?

Why don't I do the buy-and-hold? Let me count the ways: because it's like watching paint dry, produces no income, and covered call writing can produce a vastly greater return even on stocks held for investment. Speaking of which...

The Only Way Buy-and-Hold Makes Sense

Any asset worthy of owning does one of two things: grows in value or produces cash flow. The best investments do both. Why on earth would anyone want unproductive assets lying around a portfolio, like beer-bellied brothers-in-law living at your beach house? My view is that the only unproductive major asset we should own is the house we live in. Stocks that are not producing cash flow, which I refer to as naked stocks, are much like the half-naked brother-in-law spilling over the chaise lounger on the beach.

Sophisticated investors therefore take B&H to its logical and highest destiny by writing calls on the stocks to produce cash flow. They force the stocks to pay them rent. If you aren't selling call options on portfolio shares, you should be. Covered call writing can supercharge portfolio returns. You can have your shares and write (calls on) them, too.

Even the most boring, non-volatile stock should be able to produce a call-writing income stream of 8% annually, and the income stream even from blue-chip stocks can be much higher, easily 12-15% annually. Simple trading of the calls, meaning to buy and sell calls with the stock's movement, can seriously increase the returns. This is more effort than merely writing calls, and writing calls in turn is more effort than doing nothing.

And doing nothing but buying and hoping might work for you. But isn't it always a better strategy to control your own destiny to the extent you can? I think so, and I know covered calls is the right income-producing strategy for those with an investing goal. As an example, consider that hedge funds and mutual funds buy stocks and hold them… and they are some of the biggest sellers of covered calls in the world, because covered call premium income adds hugely to their overall returns. If you are an investor who has not tried call writing, you should!

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