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Is This the End for Stocks?

Historically, stocks have been the best-performing asset classes when measured over a period of decades. Unfortunately, equity investors have experienced some setbacks along the way. The past decade has shaped up to be one of those times.

Consider the following performance figures, taken from The Wall Street Journal:

  • Since March 1999, the S&P 500 has delivered an annualized return of 2.46%.
  • Over the same period, U.S. Long-Term Treasury Bonds returned 7.68%.
  • Commodities did even better, with a return of 17.92% per year.

If you include inflation, the numbers look even worse for stocks. And when you consider that a vast majority of investors fail to outperform the broad market, the past decade will probably go into the history books as one of the worst periods for the equity investor. You won't find a similar period in U.S. history unless you go back to the 1966-82 era. Before that, you have to look back to the 1929-42 period.

If you don't remember the past ...
"Buy and hold" has always been considered a cornerstone of successful investing. Warren Buffett likes to quip that his favorite holding period is "forever." In the 50-plus years that he has been an investor, he's applied his "buy and hold forever" philosophy to the likes of Coca-Cola (NYSE: KO  ) , GEICO, American Express (NYSE: AXP  ) , and Washington Post (NYSE: WPO  ) . Of course, his holding company, Berkshire Hathaway, has been his ultimate permanent holding.

Yet Buffett is not making a blanket statement. In 1999 and 2000, Buffett admitted that it might've been smart to sell Berkshire's holdings in Coke at the time. But as long as Buffett thinks Coke, or any other long-term holding, can deliver long-term returns satisfactory to him today, he's better off not selling.

... you are doomed to repeat it
Unless you can spot the next Coke -- and then buy it at the right price -- the buy-and-hold approach is not as simple as it seems. Most successful investors will profit from buying good businesses at attractive prices and holding them. But I would characterize the approach as buy at an attractive price below your estimate of value, and hold until you can sell at an even better price above your estimate of value. This approach usually requires time. If you find a great company and it continues to deliver, then you might not need to sell as the company's intrinsic value continues to increase.

However, investments do sometimes become fully valued or overvalued very quickly. That's the time to ask whether the stock is still a good value at higher levels. For instance, if you held onto -- or even worse, paid nosebleed prices for -- stocks such as Yahoo! (Nasdaq: YHOO  ) , Microsoft (Nasdaq: MSFT  ) , or Cisco Systems (Nasdaq: CSCO  ) in 1999 and 2000, you weren't getting good value for your money. I'm not saying those weren't good businesses -- they just weren't trading at attractive prices relative to their value. As a result, even though the businesses have done well, their stock prices have fallen to more reasonable levels.

Price is the determinant of value
There are advantages to the buy-and-hold method. The taxes you pay on short-term positions can be more than double the rate on long-term holdings. And obviously, frequent trading means higher commission costs.

However, you shouldn't let tax or transaction-cost considerations be the primary factor in your buy and sell decisions. Instead, you should always base those decisions on how much value you can get. It typically doesn't make sense to miss out on an unusual opportunity to sell at a high price just because you're paying tax at a higher rate.

Most good companies that you buy at attractive valuations will yield attractive long-term results. But if the market is willing to pay you twice what you paid last month, then by all means, let the market serve you and cash in. For instance, Berkshire held its investment in Chinese oil company PetroChina (NYSE: PTR  ) for less than five years, a far cry from buying and holding forever. Buffett sold the investment after he believed that the company had reached a fair value to sell. He bought at a good price compared to his estimate of its value, and he sold at an even better price above his value estimate. Do the same, and you'll make money most of the time.

At first glance, it's been a bad decade for stocks. But if you look for value in your holdings, you should do well going forward.

More value-creating Foolishness:

Microsoft, Coca-Cola, and Berkshire Hathaway are Inside Valuerecommendations. For more helpful tips to find the best values in the market, sign up today for a free 30-day trial subscription.

Fool contributor Sham Gad runs Gad Partners Funds, a concentrated value-centric investment partnership modeled after the 1950s Buffett Partnerships. He eats his own cooking and will buy back your old dollar bills for two shiny quarters. He has a stake in Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Yahoo! and Berkshire Hathaway are Stock Advisor recommendations. The Fool has an untouchable disclosure policy.

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