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Buy and Hold Isn't Enough

The market has been falling -- and the signs read rough road ahead.

The Chicago Fed's National Activity Index, a weighted average of 85 economic indicators, is falling, as are economists' GDP growth forecasts. Unemployment is back on the rise, the Fed's second round of quantitative easing is coming to an end, and the housing market remains a mess. No wonder the bears have been roaring out of hibernation!

It's not looking good
I don't know what the market will actually do. But after studying credit bubble collapses and the 10-year chart for the S&P 500 below, I'm betting on low returns and high volatility over the next 10 years -- just like last decade. Check out the chart below.

Source: Capital IQ, a division of Standard & Poor's.

I mean, 2.3% annual returns. That's all the market could muster -- including dividends! In real terms, that's nothing. Nada. Zilch.

A better way
The status quo isn't enough. We need more than bottom-up, long-term buy and hold during the next volatile decade. Otherwise we could end up generating zero real returns like I expect from the market -- or worse.

To make money in this new investing environment, here's how I am managing my $50,000 on-line portfolio.

  1. Pay attention to the trends and find the best opportunities in them.
  2. Go with the odds.
  3. Have a flexible trading strategy.

Let's take a quick look at how each of these steps works. Then, if you're interested, I'll present you with a fantastic opportunity I've found using my new approach.

Know the big picture
Today, more than ever, investors can't ignore the top-down view. Investors still have to analyze companies from the bottom up, but Peter Lynch reminds us, "A person infatuated with measurement, who has his head stuck in the sand of the balance sheets, is not likely to succeed."

He's exactly right -- especially today. I missed a 19-bagger with because I was too wrapped up in its financial statements to buy shares of the revolutionary on-line retailer in August 2001.

Lynch would not be proud. That's why I am opening up my mind and researching E-Commerce China Dangdang (NYSE: DANG  ) and Renren (NYSE: RENN  ) , the so-called and Facebook of China, respectively. Their business models have loads of potential and their stocks have been crushed recently. I think these could be very promising investments.

Go with the odds
But it takes more than potential and a falling stock price to separate me from my capital. I have to understand why the odds are in my favor. And that comes from a combination of business and financial analysis.

Take Infinera (Nasdaq: INFN  ) and Cisco (Nasdaq: CSCO  ) , for examples. Both companies sell communications equipment and, right now, the market hates their stocks. Infinera's next-generation product, its 100G photonic integrated circuit, is due out in 2012. If past is prologue, it's going to be a big hit. On the other hand, Cisco is trying to find new avenues of growth. Although I can't be sure either company will turn things around, I think the odds -- and the payoff -- favor Infinera.

Don't be afraid to trade
In the short run, psychology exerts significantly more influence on stock prices than the fundamentals of the businesses. Buying attracts more buyers, pushing prices up further, and the opposite is true with selling. In volatile markets, these swings can happen more frequently and more profoundly. Here's how volatility looked over the 1965 to 1981 stretch:

Source: Crestmont Research.

This is exactly why every investor should have a trade plan in volatile markets. A trade plan is a guide that shows when to buy when the odds are in your favor and when to sell when they are not.

I've created trade plans for two stocks I've researched: Google (Nasdaq: GOOG  ) and Caterpillar (NYSE: CAT  ) . (I've written about Google, here.) According to my estimates, buying the search ad giant's shares below $460 gives three times as much upside return as downside risk. That's an attractive point to start buying.

Shares of the earth-moving-equipment maker don't look as attractive. I estimate its reward/risk ratio is about 1. That may be OK for some investors, but that's too much risk for me. If Caterpillar were in my portfolio, I would consider selling some shares to reduce my risk.

A trade plan seems to go against the Fool's mantra. Foolish investors prefer to buy and hold -- and I do, too. But not every investment lends itself to buying and holding, because circumstances change. With volatility on the rise, trading is not a dirty word when it's rooted in solid analysis of a company's business fundamentals.

Let's make some money
Financial markets and the U.S. economy have recovered from their 2009 lows, but we're not out of the woods yet. I don't know if the market's losing streak will persist, but I do think the volatility will persist over the next decade. To be ready, I've come up with this new investing strategy because:

  1. Powerful things happen when trends converge, diverge, emerge, or combine together.
  2. I would rather be vaguely right with the odds than precisely wrong with intrinsic value.
  3. Sometimes it's better to trade, and other times it's better to hold.

I'm going to invest $50,000 of my own money with this approach, which I expect to pay off over the next several volatile years.

If you'd like to find out about the three strong trends and the money-making trade that I see, I'll be happy to send you a brand-new report I've written on the subject for free. Simply click here and enter your email address in the box to let me know where you'd like me to send it.

David Meier is an associate advisor for Million Dollar Portfolio. He owns shares of Infinera. The Motley Fool owns shares of Infinera and Google. The Fool owns shares of and has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Google, Infinera, and Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (20) | Recommend This Article (32)

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 24, 2011, at 4:03 PM, catoismymotor wrote:

    It is refreshing to see someone declare LTBH dead with their own cash on the line. I do not share your sentiment but I do hope you do well with your plan.

    +1 Rec

  • Report this Comment On June 24, 2011, at 6:03 PM, GregLoire wrote:

    Just because "buy and hold" hasn't worked very well for the past decade doesn't mean that a strategy of attempting to time the market would have fared any better.

  • Report this Comment On June 24, 2011, at 8:50 PM, vgaymer wrote:

    this is a joke right? Is it April 1 already?

    To be fair, I REALLY like this statement:

    In the short run, psychology exerts significantly more influence on stock prices than the fundamentals of the businesses.

    However timing it is another thing

  • Report this Comment On June 24, 2011, at 10:04 PM, kjm84 wrote:

    So, based on the market's performance over some arbitrary time line (the past 10 years in this case), you're saying Buy and Hold doesn't work?

    I could just as easily point to market returns between 1988 and 1998 to support a thesis that Buy and Hold is the key guaranteed wealth.

  • Report this Comment On June 25, 2011, at 12:12 AM, mattmosa wrote:

    Good article and the point made isn't without merit. Buy and hold works only if you own a buy and hold company, and the company isn't priced so high that it can't live up to expectations.

    In 1999 if you bought AOL, YHOO,CSCO, MSFT EMC, and many others, 12 years later you're still underwater and likely to stay that way for the forseeable future, probably longer.

    All superstar companies.

    Buy and hold yes, but don't chisel it in stone.

  • Report this Comment On June 25, 2011, at 1:33 AM, hrl66 wrote:

    Some stocks should be traded and some stocks can be stashed a way and watch the dividends add up. Trying to figure when to sell and when to buy and when to hold is what this is all about. If anyone has the answer to do that successfully on a regular basis my guess they are some place warm and drinking drinks with little umbrellas.

  • Report this Comment On June 25, 2011, at 2:28 AM, mm5525 wrote:

    Someone please attempt to tell Warren Buffett buy and hold is dead. The man never got near tech stocks due to something called intrinsic value and the simple fact he didn't really understand tech or be able to follow their business models. Like the above poster says, if you keep it simple and invest in staples that earn money regardless of market conditions like PG, KO, KFT with dividend protection, buy and hold certainly is not dead.

  • Report this Comment On June 25, 2011, at 2:41 AM, somethingnew wrote:

    I agree with this article. I've always been more focused on Buy and Hold throughout my investing years but I've slowly started to realize in some cases this strategy fails. Even Buffett in his early days did alot of short-term trading in commodities and stocks. I know everyone today associates Buffett with the term "Buy and Hold" but after reading Lowenstein's "Buffett-the making of an american capitalist" I started to realize this wasn't always the case with him in his early years and he made quite a bit of money through short term trading (buying and holding stocks for a couple years, short term for Buffett anyway). I've actually considered setting up another portfolio so that I'd have one for long term and a second one strictly for short-term trades (2-6 months) to buy and sell shares in companies that are undervalued but also ones that I don't care about long term.

  • Report this Comment On June 25, 2011, at 7:50 AM, dbtheonly wrote:

    I suspect we are having a definitional problem. "Buy and Hold" is not necessarily until death do us part. There are any number of reasons that one would bail on a position, hitting a stop-loss point among them.

    "Buy and Hold" is an alternative to "Day Trading" or "somethingnew's" short-term. Either way, until we agree on our terms, we are spinning wheels, generating much heat, but little light.

  • Report this Comment On June 25, 2011, at 12:16 PM, rgperrin wrote:

    So far as I know, no timing strategy has consistently produced favourable results over long periods of time. Also, as I understand "buy and hold," it isn't forever, but only until (if and when) certain (positive) company "fundamentals" begin to deteriorate.

  • Report this Comment On June 25, 2011, at 2:11 PM, Myshkin69 wrote:

    Great article. For a lot of investors in my father's generation, buy and hold meant virtually buy and forget. After at least a double which could be 6 months or 6 years, he'd sell half "then play with house money". He'd look at his statements every month, but as long as he had cash flow from his work, that was the extent of it.

    I am still a buy and hold investor, but we do not have the luxury of buy and forget. Our Foolish style should be one of strict adherence to our investing (and probably other) values in the face of turmoil in every sense of the word. We must be clear in our heads when the right time to act has come, but planted in our values and hopefully wise enough to stay the course when the fundamental reasons why we bought the company have not changed. Best to you and yours

  • Report this Comment On June 25, 2011, at 3:13 PM, TimothyVR wrote:

    This grim prognosis would mean the longest secular bear market in history - even longer than the Great Depression/WWII Bear. And we are only half way through. Depressing indeed.

  • Report this Comment On June 25, 2011, at 4:43 PM, kariku wrote:

    "Go with the odds"

    Yesh, I wish I knew how to calculate the odds. From this point of view, poker is easier.

  • Report this Comment On June 25, 2011, at 5:28 PM, Charbroil121 wrote:

    I would definitely question the article writer's assumption that value stocks don't deliver the same kind of returns as glamour stocks like Salesforce, Amazon, etc. For every highly valued company like those, there are a dozen which seem to have the same potential but which fail miserably.

    Moreover, there is overwhelming academic evidence that undervalued companies outperform high P/E and P/B companies--see below for just two examples: (Page 13)

  • Report this Comment On June 25, 2011, at 5:31 PM, Charbroil121 wrote:

    Also, it's worth noting that (just as others have mentioned), I don't think buy and hold implies buying and forgetting without consistently checking valuations, one's original thesis, etc. Indeed, it's possible to evaluate probable future returns based on current valuations--this article gives one example of a fund manager who consistently does so.

  • Report this Comment On June 26, 2011, at 1:36 PM, Morgana wrote:

    1. I love Motley Fool.

    2. I sold all but one stock two weeks ago. That was about 45 stocks.

    3. TDAmeritrade has something called Gainskeeper which calculates profit/loss. I am up over 30% this year. I would love to wave that in my last broker-who-lost-my -money-as-the-market-rose's face!

    4. I have already started putting in ridiculously low bids for stocks. I am willing to wait 6 months to a year for the crazy low price on my favorite stocks.

    5. As I said, I love Motley Fool . . . Thank you for helping me get profits.

  • Report this Comment On June 26, 2011, at 9:35 PM, daveandrae wrote:

    I have been buying and holding McDonald's since 2003, when it was trading at 13.60 a share. The share price is now well over 80 and approaching yet another all time high. My dividend yield to original cost basis is now well north of 16% annualized. Now why would anyone in their right mind sell out of a business like this?

    Buy and hold doesn't work for most people because, like so many other things in life, it depends on what you're buying and holding.

    It's very reminiscent of a marriage. If you really picked the right woman, you won't ever want a divorce.

  • Report this Comment On June 30, 2011, at 2:40 PM, hachmujt wrote:

    How do we know when to buy and sell again? I hope investors are not confused by your article.

    The most important decision is your split between fixed income and stocks. Secondly hold your portfolio for ever only occasionally re-balancing back to your desired stock/fixed split.

    Do this until you die.

  • Report this Comment On July 01, 2011, at 12:54 PM, Happymspage wrote:

    Why don't more people take a more positive attitude about this country? I'm including our great leaders in the congress and senate.They could try to make it easier for commerce to build their businesses and give the companies that have billions of cash outside the country.Congress could grant then an other amunity to bring their profits back to USA with out a heavey income tax penelity.Its been done several times before.


  • Report this Comment On July 01, 2011, at 9:24 PM, AlyByrd wrote:

    Once bitten thrice shy. Contemplating just a few of the stocks I sold entirely too early, which include: APPL, TIBX, and WFMI it becomes apparent to me that generally if I simply held on to my stocks, I would be incredibly wealthier than I am now. That said, I am going to take a gander at the holdings I do have and make sure there isn't anything that needs to be snipped -- thanks for the reminder!

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