The Wrong Way to Invest Today

If nothing else, the severity of the bear market over the past year has convinced investors that anyone who bought stocks near the top last year will have to wait a while -- perhaps a very long while -- to get back to even.

That's a sobering thought. Many see it as the death knell of long-term investing, arguing that only suckers buy stocks and hold onto them for years, riding the waves up and down without ever cashing out. Looking at the way so many investors have given up all their gains (and then some) on long-held stocks, you might think there's something to those skeptics' opinions after all.

A better way to profit?
Short-term traders point to the recent volatility in the stock market as evidence that their methods are superior to the long-term buy-and-hold strategy. Simply by buying in at the recent market lows, traders have realized 20%, 30%, or even greater returns in less than a month.

Moreover, you didn't even have to be that good of a stockpicker to cash in on those outsized gains. Take a look at some of the names, along with their recent performance:

Stock

Return Since Nov. 21

Wells Fargo (NYSE: WFC  )

37.8%

Nokia (NYSE: NOK  )

27.7%

Home Depot (NYSE: HD  )

29.4%

MetLife (NYSE: MET  )

83.4%

Target (NYSE: TGT  )

27.2%

Amazon.com (Nasdaq: AMZN  )

40.4%

Source: Yahoo! Finance. Prices accurate as of Dec. 17 market close.

For many stocks, you could have earned several years' worth of appreciation in just the past four weeks, based on the long-term average return of 10% for stocks. And although many traders can't claim to have timed the bottom exactly, those who had the courage to buy near the lows have already earned substantial rewards.

With those sorts of gains available in such a short period of time, why should anyone take the risk of holding stocks long-term?

An extraordinary period
Before you decide to quit your job and become a day trader, though, take a step back. Over the past several months, market volatility has risen to record levels and beyond, with sharp, vicious moves both up and down that have surprised nearly everyone. Those extreme price movements have made it possible for short-term traders to make huge profits in just days and weeks.

That level of price movement, however, isn't too common historically. Traders typically have to endure long periods during which stocks trade within much narrower ranges, making it difficult to use the same strategies that work so well when prices gyrate wildly. All the while, they risk finding themselves on the sidelines -- or even worse, on the wrong side of the trade -- when a major trend shift occurs.

Use volatility for the long term
Long-term investors can take advantage of short-term price movements, too. But by keeping an eye on farther horizons, they set their sights higher as well.

Sure, returns of 25% and more in just a month are nothing to sneeze at. But the surest strategy to build true wealth involves finding the best companies and holding onto them.

Just think: Traders might well have sold Google (Nasdaq: GOOG  ) for a quick 50% profit just two months after its 2004 IPO, only to see it more than quadruple in the ensuing years. They would happily have bought and sold Amazon stock repeatedly during the 1997-99 tech bull for decent gains, and congratulated themselves for missing the crash that followed -- but they wouldn't own shares that have risen 35-fold in the past 11 years.

So if you're thinking about abandoning the idea of holding stocks for the long term, don't just look at the potential gains you could make with your short-term trading. Think also about the long-term profits you're giving up. With stocks trading at such attractive levels, now's not the time to settle for anything less than the multibagging results that long-term investors enjoy.

More on how to invest right now:

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Fool contributor Dan Caplinger does his best to avoid the temptation of quick gains. He doesn't own shares of the companies mentioned in this article. Nokia and Home Depot are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers selection. Amazon.com is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy always leads you the right way.


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  • Report this Comment On December 18, 2008, at 8:24 PM, dividendgrowth wrote:

    Yeah, if you pick the right bottoms you might make some quick bucks.

    Look at DRYS, up 300% since its November 21 bottom. But chances are you would pick one of the many wrong bottoms between May 22 and Nov 10, and be stuck with losses between 10-80%!

    Bottom fishing is generally a futile and dangerous activity. Few got lucky, most got killed.

  • Report this Comment On April 02, 2009, at 2:01 PM, notstressin wrote:

    read "A Tale of Today" at financialtales.com

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