Lots of people talk about buying and holding as the best investment approach. But not all of them practice buying and holding as I see it. Here are some thoughts I shared recently with listeners on a Sound Investing podcast. For convenience, I’ve organized this as a list of 10 ideas, but many of them affect each other, and sometimes one blends into another.

Point #1: Buying and holding is not dead

Some articles and commentaries in the past year have boldly proclaimed that buy-and-hold is dead or in some way has “stopped working.” That’s nonsense. What’s happened is that people aren’t following it as much as they once did. We’ve all seen examples of how common courtesy is less common these days. But that doesn’t mean that courtesy is “dead” or that it “doesn’t work anymore.”

Buying and holding, when it is practiced, still works as well as it ever did.

Point #2: Many people talk about buy-and-hold without knowing exactly what it is

Investopedia.com, an Internet education site for investors, defines buy-and-hold this way: “A passive investment strategy in which an investor buys stocks and holds them for a long period of time, regardless of fluctuations in the market. An investor who employs a buy-and-hold strategy actively selects stocks, but once in a position, is not concerned with short-term price movements and technical indicators.”

Although that definition refers only to individual stocks, I think the term “securities” could be substituted to make the concept also apply to bonds, mutual funds, exchange-traded funds and other investment vehicles. In addition, the way we practice buy-and-hold includes periodic rebalancing, which does respond to short-term price movements, but in a mechanical way.

Point #3: Long-term investing takes a very long time

Investopedia.com doesn’t specify exactly what it means by “a long period of time.” To a day trader, next week could be an excruciatingly long time to wait for results. In my view, the only true buy-and-holder is someone who commits to holding an investment for a lifetime, or until it’s time to sell in order to raise cash. If you sell for any other reason, you can be considered a trader (but not necessarily a traitor!).

As you will see in my next point, when you sell part of an asset to rebalance, I don’t regard that as abandoning your commitment to the asset. If rebalancing were “prohibited,” buy-and-hold would make it impossible to maintain a given level of risk over time.

Point #4: You can buy and hold and still manage your account prudently

You can rebalance your assets once a year and still be a buy-and-hold investor. And you can occasionally change your overall asset allocation to take less (or more) risk and still be a buy-and-hold investor.

The annual rebalancing we recommend is consistent with buying and holding. When people abandon a buy-and-hold approach, they tend to sell assets that have been performing poorly and plow more money into things that have been hot recent performers. That is certainly not buying and holding; it’s more like market timing based on what you see in the rear-view mirror.

But when you rebalance, you do just the opposite. You sell some of what’s been doing well and buy what’s been doing relatively poorly. Rebalancing, in effect, reaffirms your commitment by bringing your portfolio back to the mix you want to hold.

What about changing your allocation from 70 percent equities to 50 percent equities as you reach the age of retirement? That can certainly be a prudent move, and it doesn’t seem to me a bit like market timing unless it’s done as a reaction to the market itself.

Point #5: Many investors think of themselves as buyers and holders but don’t act like it

Roughly seven out of eight people say they believe in buying and holding, but I believe that only about one in eight actually do it. The rest act like market timers.

Many investors buy mutual funds thinking they are making lifetime commitments, but there is often an unspoken bit of “fine print” lingering in the back of their minds. They are committed to holding only “good” funds, not “bad” ones. And they usually have no trouble telling the difference: A “good” fund is one that goes up, and a “bad” fund is one that goes down.

This is very understandable on an emotional level. But one of the most important things investors need to remember is that their emotions are terrible guides to investment success.

Point #6: The most common reason that investors abandon a buy-and-hold approach is that they have exposed themselves to too much risk

Many investors believe they have reduced their risk by buying a mutual fund and then sitting on it. But quite often they bail out of their carefully chosen mutual funds when those funds fail to live up to expectations. Usually this happens after they experience short-term losses that were, or should have been, well within the range of expected possible outcomes.

Point #7: Some investors shouldn’t hold onto investments as long as they do
 
Despite everything that buy-and-hold implies, sometimes it makes sense to recognize a mistake and cut your losses. I’m still amazed by investors who are so committed that they hang on no matter what. Some mutual funds have been at the bottom of their asset classes for decades. I have trouble understanding why shareholders stick around.

Point #8: You’re not really a buyer-and-holder if you buy a fund with a heavily traded portfolio

If you really believe in buy-and-hold, I think you should be investing in passively managed funds. However, some people think they’re buying and holding when they hang onto a fund in which the managers actively trade. I recently talked to the manager of a mutual fund that has had a 500 percent turnover rate for years. You can pretend to be a buyer and holder while you hire a manager to buy and sell for you. But if you do that, you are defeating one of the big benefits of the buy-and-hold approach: low trading costs and taxes.

Point #9: Buying and holding makes the effect of a front-end load worse, not better

If you give up 5 percent of your money in the form of a sales commission on the first day you own a fund, your returns obviously will be less. What's not so obvious is the fact that most load funds have higher operating expenses as well. This means that every year you keep the fund, you’re receiving less return for the level of risk you are taking to own the fund’s assets.

Point #10: Being a buy-and-hold investor may be relatively simple, but it’s not necessarily easy

Our emotions can get in the way even when we try hard to follow a sensible long-term plan. Some studies show that buy-and-hold investors are more likely to hold their funds for the long term if the funds rise in value in the first few months of ownership. In other words, if you buy a fund and right away it goes up, you may feel that your choice has been validated, that you have bought a “good” fund that’s worthy of your loyalty.

If on the other hand you buy a fund that immediately goes down, you may find it very hard to “trust” that fund. Statistically, you are much more likely to hang onto the fund that immediately makes you feel good than the one that immediately makes you feel bad.

The investment industry can make this even worse. The financial interests of most brokers are served when you sell whatever you own and make a change to something new. The industry knows how to sell what’s been performing well lately, even when there is no evidence that recent past performance can accurately predict long-term future performance.

What should investors do with this information?

If you’re truly embarking on a buy-and-hold approach, your choices had better be right the first time. You need to invest in the right asset classes, including the proper amount of fixed-income funds to keep your risk under control. You need to find funds that have low expenses, low turnover, high tax efficiency, plenty of internal diversification, and managers who aren’t trying to beat the market. Index funds seem just right for this.

Educate yourself before you jump in. If you have read this far, you’re obviously somebody who takes investing seriously. So I’m hoping you will be willing to do some additional reading. Here are four investment books that can make a huge difference, whether you’re a young saver or a retiree trying to get the most from your money.

The Little Book of Common Sense Investing by John Bogle;
Your Money and Your Brain by Jason Zweig;
Live It Up Without Outliving Your Money by Paul Merriman;
Mutual Funds for Dummies by Eric Tyson

You can buy all four books online for less than $50. This could be the best investment you ever make, as the eventual payoff from this education could add up to tens or even hundreds of thousands of extra dollars for you and your heirs. If you don’t want to spend $50, you can go online to FundAdvice.com and study the recommended articles you’ll find listed on our home page.

If you want to be a successful buy-and-hold investor, these educational resources will put you on the right track. They will also help keep you on that track so you can buy the right assets and hang onto them intelligently.

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