Buy-and-hold investing isn't just a label investors slap on. It takes education and the right mindset. If you approach investing with the right tools, however, you can buy and hold with the best of them.
In the interest of being prepared, then, here are five things I'd pack if I had to put together a buy-and-hold investor's emergency road kit.
1. Ask yourself, "Why did I buy?"
If you can't articulate in a few short sentences why you bought a stock, or why you want to buy a stock, why buy it? This is one of the most valuable pieces of investing advice I've ever heard, and it was former Fidelity Magellan Fund manager Peter Lynch I heard first say it.
The act of writing down a few lines about the stocks in your portfolio provides two benefits. First, it makes you state your case clearly, hopefully in a way your grandmother could understand. Second, if you start having doubts about the stock, take out the paragraph and reread it. Has anything changed? Is further research required? It gives you a starting point for further action, if warranted.
2. Remember: Stocks are wickedly volatile
Not only do stocks go down -- anyone with a pulse for the last five years knows stocks go up -- but they stay down, sometimes for prolonged periods. Count on it. In the Rule Maker Portfolio, for example, we're ready for our stocks to underperform relative to the market -- perhaps for a long time, since the market doesn't always reflect business performance, especially in the short term. As long as the businesses continue to generate healthy cash and create value, we'll continue holding.
Check out the stocks in our portfolio as of Friday. Four of the 11 companies we own are in negative territory since we bought them. Here's the list:
Company Cost/Share Loss
JDS Uniphase (Nasdaq: JDSU) $100.75 6.3%
Coca-Cola (NYSE: KO) $69.11 17.3%
Yahoo! (Nasdaq: YHOO) $80.52 25.5%
Nokia (NYSE: NOK) $47.50 30.3%
I'm not surprised. In fact, even though the market is a little crazy in the short term, I don't think it's overreacting on every front. Rather, I think it's asking some valid questions about these companies. Can Coca-Cola increase case volume and sales? Can Yahoo!, Nokia, and JDS Uniphase live up to their rich valuations? Reasonable investors disagree on these issues.
Just for kicks, let's see which Rule Maker stocks were down a year ago.
Company Cost/Share Loss
Schering-Plough (NYSE: SGP) $47.99 3.5%
T. Rowe Price (Nasdaq: TROW) $33.67 11.5%
Coca-Cola (NYSE: KO) $69.11 28.1%
As of Friday, Schering-Plough and T. Rowe Price were up 6.3% and 27% from our original cost basis, respectively, so we take the ups and downs in stride.
3. Filter the noise
One of the most attractive aspects of Rule Maker investing is its simplicity. Our strategy doesn't require that you follow every news release, news story, and market ripple. We hope you enjoy investing enough that you'll follow your investments. It's important to learn as much as you can about how your favorite companies generate cash and we think it's worth the trip. But this approach doesn't require sticking yourself to a Quotron 20 hours a week.
In fact, doing so could cost you in the long run. Paul Andreassen, a Harvard psychologist, demonstrated with two test groups that investors who paid close attention to daily news reports performed worse than those who ignored the constant flow of water over the news wheel. For more on this story, check out Gary Belsky and Thomas Gilovich's excellent book, Why Smart People Make Big Money Mistakes.
Now, I think investors should be careful with this concept. We aren't advising ignorance. I like following news stories, since I want to learn as much as possible about my investments. But I don't reevaluate my investing decisions every time I read a story. If trading is in the back of your mind every time a news item crosses your desk, you probably shouldn't own stocks, or you should just own an index fund or low-cost mutual fund. After five years of reading and writing news stories, it's my opinion that 80% of what crosses the wires has no bearing on a company's long-term business prospects.
4. Keep expectations realistic
Over the last 10 years, the S&P 500 returned 17% annually, on average. Even more amazing is that we've had even better performance in other decades. The compound average annual return of the S&P 500 in the 1980s was 17.6%, and in the 1950s it was 19.4%.
Clearly this isn't the norm. In the 1930s, the compound annual average return of the S&P 500 was -0.05%; in the 1970s it was 5.9%, and in the 1960s it was 7.8%. Most investors know that, over the last 70 years, the market has averaged a return of 11% annually. The problem is that it's easy to lose track of numbers in a bull market.
Have investors forgotten that a 10% annual return on an investment is fantastic, or that an investment that grows 12% compounded annually will double in six years. Find a bank savings account or a quality bond that can do that. As former Acorn Fund Manager Ralph Wanger pointed out, many investors -- especially those who start early -- don't need to do better than this. So, ask what your expectations are, whether they're reasonable, and then judge the performance of your stocks against a long-term horizon.
5. Have a long horizon
The Rule Maker is one investing style. We like its simplicity and focus on quality businesses. That doesn't mean it's right for everyone or that your retirement portfolio should be loaded with Rule Makers. Investors should understand just how long-term the Rule Maker Portfolio really is.
We don't need this money to live on, not next year, not in five years, not ever really. We hope that, after 30 years, we'll have a nice track record of beating the market by a few percentage points and a tidy retirement nest egg (not that it's ours to spend). We would consider that a grand success for our teaching portfolio.
I hope this makes it clear how long our horizon is. At the Fool, we don't think you should have any money invested in the stock market that you'll need in the next five years, at a minimum. If we needed this money for retirement in 2005, you think we would have put 7% of our assets in JDS Uniphase? If we had, I'd be panicked about it falling 6% since February, too.
We're prepared to wait a long time, and our portfolio has a place for stocks such as JDSU. We're prepared for the risks. If your portfolio doesn't have a place for it and you're not ready for hard times, don't jump in. It's impossible to be a buy-and-hold investor if the basics aren't in place.
For investors thinking of long-term horizons and being prepared for the future, consider signing up for The Motley Fool's Roadmap to Retirement Online Seminar. During this 12-lesson, four-week seminar, investors will figure out how much they need for retirement and how to build an investment strategy to get there. Enrollment ends November 2.
Have a great day.
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