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Long-Term Buy and Hold May Not Be the Smartest Investing Strategy

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The financial crisis and the subsequent swoon in the stock market is calling into question the long-term buy and hold strategy and the level of risk associated with holding stocks -- even blue chips such as General Electric (NYSE: GE  ) , Citigroup (NYSE: C  ) , or ExxonMobil (NYSE: XOM  ) -- over the long term.

As part of the Fool's series to answer the question, "Is long-term buy and hold dead?" I spoke with Bryant Riley, founder of Riley Investment Management and investment banking firm B. Riley & Co. Rather than focusing on the big-cap Boeings (NYSE: BA  ) of the world, Riley and his team focus on small caps like Silicon Storage Technology (Nasdaq: SSTI  ) and Integrated Silicon Solutions (Nasdaq: ISSI  ) .

Riley isn't sure whether the strategy "buy and hold" is dead, but he doesn't think it's a smart way to invest. "I've never been a believer in buying a company and holding it forever," he said in an interview. "Our average holding period can be three to five years, but that would assume that the market is more efficient than it is. In my opinion, the market gets oversold and underbought, and that's the opportunity."

Riley bases his strategy on hard valuation. He examines price targets based on valuation metrics. "For us to just say, 'OK we'll hold on to XYZ -- it's a good company,' and then just let it blow through a valuation, isn't reasonable in our view. ... The market has a tendency to overshoot on both sides of the equation, so we will take that opportunity to move on to a different situation that might be valid to what we think is undervalued [or overvalued.]"

One way Riley and his team examine prospective investments is by looking at a company that is encountering difficulties because of the macroeconomic slowdown, but is well-positioned for an economic turn. "We'll say right now it's trading at, say, three times cash flow; they're a market leader, and we think that in a normalized environment they should trade at six or seven times cash flow," he said. "If it reaches that price, we'll be disciplined about selling it."

Riley also points out that when he looks at stocks on screens, he looks at them as businesses. "I try to forget the fact that they go up and down," he said. Riley also says he hopes one thing that individual investors have learned from the market meltdown is that stocks are companies, not just numbers on a screen.

If investors don't have the time to scrutinize individual stocks, Riley recommends either buying companies you know or buying indexes or exchange-traded funds (ETFs). "I think it's a much better strategy to buy companies that you understand," he said. "If you can't do that, then own a basket of them through indexes, which will also keep you diversified."

Riley also says individual investors should put money to work in both U.S. and foreign stocks.

In terms of future investing opportunities, Riley says he thinks there are going to be a lot of opportunities to make money in the stock market in the next 10 years, especially in specific companies.

He notes one source for future gains is going to be a lot of merger and acquisition activity, as consolidation accelerates and larger companies gobble up smaller companies. "The benefits of the whole sub-$500 million public company market have reversed themselves," Riley said. "They're all negative now, as expenses overtake income."

Right now, Riley says he thinks people are underinvested. "It seems to me that people are being overly conservative and need to come back into the market. I would be more bullish than bearish."

Readers should note that Riley's approach -- though successful -- might not fit for everyone. Weigh in with your opinions on Riley's approach and "long-term buy and hold" by leaving a comment below.

For more Foolishness:

Jennifer Schonberger does not own shares of any of the companies mentioned in this article. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 12, 2009, at 4:52 PM, dudemonkey wrote:

    Funny how all the people who make commissions on trades are saying that buy-and-hold doesn't make sense and you should trade more. We should probably also listen to the CEO of Phillip Morris when he says that cigarettes have Vitamin C in them.

  • Report this Comment On June 12, 2009, at 5:54 PM, alexxlea wrote:

    Debates like this are ridiculous. Day-trading works for me. Do whatever works for you. Everyone will have their own returns over the long haul so aggregate statistics are pointless. There will always be under and overperformers relative the market.

  • Report this Comment On June 13, 2009, at 10:16 AM, lotontech wrote:

    If buy and hold works, all well and good. But if it doesn't, then you don't find out until it is too late :-(

    Why have a fixed preconceived timescale at all? You buy a stock that you think will go up in the short term, and if it keeps going up over the longer term -- while paying good dividends -- then you keep holding it. Maybe this is what Warren Buffett means when he says that the "ideal" period to hold a stock is forever. Note my placement of the word "ideal" in quotes.

    The "ideal" time for my marriage to last will be forever, until my spouse doesn't turn out to be a psychopath somewhere down the road ;-)

    While working on the manuscript for a new book recently, I found myself writing:

    "Hold for as long as possible -- but no longer"

  • Report this Comment On June 13, 2009, at 7:15 PM, TimothyVR wrote:

    Are you saying that buying and holding Coke or Johnson and Johnson or Pepsi and accumulating dividends even if the price drops is now "out of date"? Since when?

    Surely the buy-and-hold strategy is necessary for the dividend system to produce results. I don't know what to make of this article

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