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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...
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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