Fool's Eye View

[ November 21, 2000 ]

Long Term Buy & Hold -- The Rules

By Nigel Roberts (TMFNigel)

Chippenham, Wiltshire -- Let me tell you, Fools, buying and holding quality companies for the long term really is the only way to be sure of benefiting from the magical effect of compounding. But it has to be recognised that the buy and hold strategy is much easier said than done. We believe in the long-term buy and hold strategy (LTB&H) here at the Fool because we know you can't time the market. There is no magic indicator telling you to sell when the market peaks, and likewise, no one will be able to announce that the bottom of market has been reached during any particular cycle. Anyone professing to be successfully and continuously selling at the peaks and buying in the troughs is either lying through their teeth or being incredibly lucky.

Over any period of time, companies will go through bad patches. Earnings growth will slow or stop, external factors will affect the business, management will get things wrong... the list is endless. For LTB&H'ers, it is at these times that the temptation to sell is at its highest. But here at the Fool, we advocate selling a share when something material about the company has changed. But spotting what is "material" is very hard. If you follow every announcement about a company you could end up believing that something truly material has changed, when in reality nothing much has happened.

Long term buy and hold is not an exciting strategy. It may mean that you hold onto a small number of companies, and you might end up buying and selling only one or twice every year or two. This is boring, and it can be very tempting to sell one share to buy another. We all know that finding the next hot share is the one of the most exciting things about investing, but we must never forget that the reason we are investing is not about excitement, it is not even about having fun -- although I admit that I consider investing to be my number one hobby. Investing is about making the money you have now grow at a faster rate than you would get if you stuck it in a no-risk investment, like cash in a bank.

Recently over at Fool USA Richard McCaffery (TMF Gibson) produced a list of five tips for long term buy and hold investors: which I will adapt here, and which I hope will help LTB&H'ers to keep on the right track and be happy with their boring portfolios!

1. Ask yourself, "Why did I buy?" -- If you can't articulate in a few short sentences why you bought a stock, or why you want to buy a stock, why buy it? Never buy on a whim or a tip, and always understand the reason that you bought in the first place.

2. Remember: Stocks are wickedly volatile -- Not only do stocks go down, but they stay down, sometimes for prolonged periods. Don't buy shares in companies if you cannot accept the downside. Never buy shares unless you are able to accept that you could lose 50% of your investment in a short period of time.

3. Filter the noise -- Watching each and every bit of information coming to you about stocks can make you take decisions too quickly, and for the wrong reasons. 80% of what we read about particular stocks has little bearing on the long-term potential of the company.

4. Keep expectations realistic -- The market has returned 12% compound since 1918. To achieve 12% in the future would be fantastic. To achieve 10% compound a year would be excellent. Don't expect to achieve 20% each and every year. If you have been achieving 50% compound in the past then you have been taking massive risks, and you must also be prepared for that risk to one day come along and hit you like a sledgehammer. Be prepared and be happy to accept lower returns for long term investing.

5. Have a long time horizon -- Don't invest money in the stock market that you might need in a short time. If you are thinking about buying a house in a few years' time, don't risk the money that you are saving for this on the stock market: stick it in a high-interest bank account. Only invest money that you are happy to tuck away for a very minimum of 5 years, and preferably much longer. How about setting a time horizon of 30 years or more?

What does this mean for LTB&H'ers?

Most of us have lives outside investing. We have families that we should be spending time with, we have hobbies that we should be doing, we have lawns to mow, and we have holidays to take. Most people do not have the time or the inclination to be able to study the market in any great depth and to select those few quality companies that they can hold and hold for the long term. If you are in this position, can you still build a long term buy and hold strategy?

Yes, of course! Probably the best LTB&H strategy is for you to save regularly in an index tracking unit trust. Regular savings of relatively small amounts of money can grow into a truly huge sum over the long term, and by investing in an index tracker you will be much less likely to tinker with your investments. Index trackers may well be boring, but boring is just the way LTB&H'ers should want things!

Where Next?

• The miracle of compound returns
• Buying the market -- no brain investment
• Fool's Guide to ISA's