Online Stock Trading versus Buy-and-Hold

On this site we have long taken the position that buy-and-hold is a potential suckers bet. That has never been more true than it is right now. With the stock market churning in record territory, you may be better off holding individual stocks through online stock trading, rather than holding funds that you are prepared to sit with for the next 10 or 20 years.

When markets reach new highs, the investment strategies that won the day earlier in the market cycle usually don?t work any more. And that calls for new strategies.

Buy-and-hold in a record market

As a strategy, buy-and-hold has its finest moments early in bull markets. If you can get into the market after major blowouts, such as the 2000 ? 2002, and 2007 ? 2009 markets, you can get explosive returns simply by sitting in mutual funds and exchange traded funds (ETF?s).

Online Stock Trading versus Buy-and-Hold
Online Stock Trading versus Buy-and-Hold
But as markets move toward new highs, the peaceful tranquility of buy-and-hold can become something of a fools game. The same dynamic that resulted in spectacular gains on the way up, reverses and takes a heavy toll on your portfolio. This can be especially true with managed funds, which seem to do especially poorly in declining markets.

Rather than viewing buy-and-hold as a permanent investment strategy, it may be best to use it as a temporary strategy that is best employed after a market collapse. At that point, stocks are cheap and you can ride the elevator up when the market begins rising. Stock selection is far less important at the beginning of a bull market than it is near a market top.

The importance of being ready for anything

Record markets favor special situations. Right now, we are most definitely in a record market. That should make us begin to think about changing investment strategies.

For starters, this is an excellent time to reduce exposure to the equity markets. Increasing positions in no risk or low risk investments should be a high priority. It should include moving money into treasury securities, certificate of deposit and even money market funds.

Not only do fixed income investments protect your portfolio value by reducing your exposure to equities, but they also provide you with a solid base of cash-type investments that you can draw on later on to buy stocks after the next sell off. You can bet that one is coming.

On the equity side, you might want to consider greater emphasis on individual stocks, rather than on funds. In peak markets, investors become much more selective. It?s no longer a matter of pouring your money into anything stock market related, and waiting for it to rise in value. Investors begin looking for special situations, including high dividend-yield stocks, stocks that are out of favor, and stocks of companies that are outperforming their competitors in their industry.

Not as easy to determine are stocks that stand to benefit from reversals in either the stock market or the economy. They may be the best performers of all, but you?d need a crystal ball to find them before the fact.

Trading quick and on the cheap

One of the biggest problems of trading individual stocks is fees. Quite simply, trading individual stocks ? unlike taking long-term positions in mutual funds and ETF?s ? often requires that you make more trades. Since there is a transaction fee associated with any trade, more trades equals higher fees.

Transaction fees are a big enough problem in the way that they eat into your investment gains. But they add insult to injury if the investment goes sour and you have to sell at a loss.

If you?re going to trade individual stocks ? and even funds ? quickly and inexpensively, you?ll need to find a good but inexpensive online investment broker. For example, you can
buy shares online with E*Trade
, and other online brokers for just a few dollars per transaction, and with minimal maintenance fees.

If you?re going to trade stocks, and you need execute orders quickly and inexpensively, you can have an investment account set up with just such an online broker. And in this market, you absolutely need to have just such an account.

With the market being top-heavy, we need to be prepared for whatever may happen. Should the market begin to reverse, it could do so in spectacular fashion. That would leave little room for last-minute maneuvers. You need to have your portfolio set up in such a way that a substantial amount of your capital will be preserved, and that you have the ability to make a quick exit out of any failing equity positions, and into the newest rising stars.

Are you considering making changes in your investment strategy given that the market is in record territory?

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9 Responses to Online Stock Trading versus Buy-and-Hold

  1. My strategy hasn’t really changed all that much. I have a large basket of high quality banks, REITs, and utility companies that pay dividends. (Some quarterly and some monthly) The price has a “low beta” which means it correlates to the market movements up and down, but not to the same degree.

    For additional cash I sell near-the-money naked PUTs on index etfs. If the index goes down a bit, goes nowhere, or goes up, then I keep the proceeds of the sale and walk away at the option expiry. Or close out the position if it’s done most of what it can. If the market goes down, then the PUT forces me to buy the index ETF at the contract price which I can then either sell at a small loss, or wait until the index bounces back up in price a day or three later for a small profit. My track record to date for the year has been 37 successful trades and 2 that were closed at a small loss.

  2. I think that with the dividend stocks you should do OK, even in a major slide. I wouldn’t change that strategy a whole lot, it sounds pretty “all weather”.

  3. I’m personally a buy & hold man. I think the numbers are there to show it is an effective strategy in the long term and it appeals to my lazy nature!! 🙂

  4. I think the timing on buy-and-hold matters. A couple of years ago, there were no small number of buy-and-holders complaining they had made no progress in the previous 10-12 years. At the top of a bull market, it seems to work. But once a slide takes hold, it falls apart and it could take years to get back to winning territory. I see it as a dangerous strategy in record markets.

  5. While I don’t necessarily disagree with the strategy you put forward (I’d prescribe to it myself), but I think when you generalize investors into an “average investor”, your average investor doesn’t have the knowledge, time, care, experience, etc etc to watch the markets and try to time it. More often than not, they will probably sell low and buy high.

    So I think buy and hold through regular dollar cost averaging in low cost index funds is the safest strategy for the average investor to save and grow money.

  6. Hi Steve – You may be right about dollar cost averaging. The problem is a lot of investors load up at or near the top of bull markets and take a bath on the way down. Then they sell at the bottom. Whether it’s buy-and-hold or a active stock strategy, they tend to do the opposite of what’s really needed to come out ahead.

    The issue I have with buy-and-hold is that people hold through market tops, then get burned by the fall. That sets them up to sell at the bottom. But even if they didn’t, they’d still take years to get back to where they were at the top.

    I’ve never seen the stock market as the passive investment so many think it to be, ie, buy and hold no matter what. It’s never been that simple.

  7. Along with the dollar cost averaging factor, I think also a lot of people get confused between “buy and hold” investing and “buy and rebalance” investing. By rebalancing to asset allocation targets, it helps curb risks.

  8. Hi Jacob – I agree. But I also think you can use rebalancing to reduce exposure in high markets, and raise it after a significant downturn. I think people often mistake buy-and-hold for fire-and-forget. Unless you’re investing in CDs or Treasury bills, there’s no such thing as a passive investment. They all need tweaking as circumstances change.

  9. The buy and hold method has burned many investors. I think looking at an option strategy instead something as simple as covered calls can be of much better benefit. Other alternatives to stocks or shares would be ETFs, which can potentially help reduce the risks.

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