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Buy and Hold Isn't Extinct, But It Needs to Evolve

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It can be very profitable if investors execute it with the mindset of buying and holding until the facts change.

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At a recent CFA market outlook dinner, the guest speakers concurred that long-term buy and hold will under-perform in 2010 and will continue be a difficult strategy to employ in the future.

This is by no means revolutionary. Buy-and-hold naysayers emerged immediately following the financial crisis and housing bubble crash that caused disarray throughout capital markets.

But it was a shocking message coming from a panel at a CFA affair. As a candidate in the program, I am familiar with the CFA Institute's intense focus on fundamental analysis.

On the one hand, there is some value to this proposition. Throughout the decade, technology has changed the playing field of the market and allowed short-term strategies to succeed. The ability for new news to be almost instantaneously priced into the market upon announcement can cause stock prices to fluctuate irrationally, sometimes based on just numbers or speculation alone rather than the actual analysis of a company.

Further, more frequent and intense bubbles and collapses have caused drastic market-wide swings that cause mass divergence between a company's intrinsic value and its stock price. The 2008 global financial crisis is a solid case in point.

However, suggesting that buy and hold is dead essentially means that the fundamentals of a company are worthless. The thought of that notion is ludicrous.

(See also, Five Investing Myths Debunked)

In many cases, investors are extremists. One group believes in solely analyzing fundamentals and buys a stock to hold forever. Another group covers up the name of the company and trades only on quantitative factors.

But extremism tends to fail. I witnessed it first-hand in the investment industry during employment at my last firm. Die-hard buy-and-hold-forever investors refused to let go of overvalued companies they believed in for the long run and snubbed macro event market movement only to eventually end up deep in the red.

Like anything, investment strategies need to change. And they need to be modernized to remain relevant. Finding great stocks to hold for a long time combined with trading on macro news and changing valuations seems more realistic than holding a stock forever.

This is precisely why Warren Buffett and his Berkshire Hathaway (BRK.A) holding company have remained so successful. As one of the greatest buy-and-hold investors of all times, Buffett's philosophy has been studied and talked about extensively. Interestingly enough though, his strategy is widely misunderstood.

(See also, What Buffett Got Wrong)

Buffett undoubtedly focuses on fundamental values of a company and purchases stocks with a buy-and-hold mindset. He looks for companies with strong brand names, like Coca-Cola (KO), Kraft (KFT), Goldman Sachs (GS), and General Electric (GE). But he still trades on macro news and sells when investments become overvalued. In the past, he sold McDonald's (MCD) and Disney (DIS) when he no longer felt they were worth his capital.

In other words, buy and hold can be a very profitable investment strategy provided investors execute it with the mindset of buying and holding until the facts change.

Purchasing a fundamentally strong company when its price is attractive works. Loading up on more of that stock if the price slips on short-term news works. When either a company becomes overvalued or its business model begins to negatively change, selling works.

Exact market timing isn't necessary. The strategy is simply picking solid stocks and using common sense.

The bottom line is that the buy-and-hold portfolio is not extinct. It just needs to evolve.
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No positions in stocks mentioned.
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