The Biggest Danger to Your Portfolio

Buy-and-hold investing isn't dead by a long shot. If you think the perfect holding period is measured in years rather than hours, then you're rapidly falling out of touch with the herd mentality on Wall Street. But that's not a bad thing, because the temptation to stop thinking about your stocks' long-term prospects poses the biggest danger to your investing success.

A faster world
Advances in trading technology have made it far easier for short-term traders to implement their strategies than it was even 10 years ago. The simplistic program trading that was widely blamed for exacerbating the 1987 stock market crash has evolved into much more sophisticated high-frequency trading algorithms that are smarter and far faster than ever before.

Moreover, with information flow growing ever faster, trying to capitalize on new information is practically impossible for ordinary investors. The pace at which new information becomes available makes it easy to reassess opinions on particular companies, motivating traders to buy and sell more frequently as their future outlooks on stocks change.

Nobody's holding anymore
The result with many companies has been a dramatic increase in trading volume compared with the total number of shares outstanding. Take a look, for instance, at just how quickly the entire float turns over for some stocks:

Source: Yahoo! Finance. Share figures in millions. Volume is average over past three months. *Total shares outstanding; float data unavailable.

With volume at such high levels, it's clear that many investors don't hold onto their shares long enough to care about their prospects for next quarter, let alone years down the line.

But that doesn't mean that long-term investors should give up their focus and start paying attention to every bump and dip in their stocks' prices. In fact, the current emphasis on short-term moves is just a more extreme example of what buy-and-hold investors have always had to face.

Nothing new
Professional traders have always had a shorter time horizon than the typical ordinary investor. Consider some of the ways in which stock analysts and the company executives who work with them feed short-term hype:

• An inordinate amount of investor attention is focused on quarterly financial results. Although getting a regular gauge on how a company is doing helps long-term investors assess whether they still have confidence in their investment, the huge moves in share prices that come when a company misses or beats estimates even by a single penny per share are often completely out of proportion to their actual impact on a company's intrinsic value.
• In giving recommendations on whether to buy or sell a stock, analysts often put share price targets on the companies they study. Doing so can sometimes put more emphasis on short-term stock movements while distracting from a company's underlying business activities.

It's tough to keep a long-term perspective with the blitz of information available to you. But it can be done -- and doing so is well worth the effort.

Ignore the noise
Having owned shares of a privately held stock that was revalued only once per quarter, I can vouch for how different an experience it is as an investor. Instead of letting share price movements mislead you into thinking that the company's business was fundamentally changing, you instead spend more time actually looking at the business yourself, becoming more familiar with company financials and the trends they follow.

And when those valuations came in, that familiarity allowed me to figure out how the shares were being valued. After a while, I could anticipate price movements based solely on the latest financials.

With public companies, of course, share prices change all the time. But that doesn't mean you have to pay attention to them. By looking at company fundamentals, you should be able to come up with your own estimate of intrinsic value -- and then do your own analysis to see how that value changes over time. As long as it stays above your estimated fair value, then you should be happy with your investment -- even if the market price of the stock fails to follow suit temporarily from time to time.

Short-term traders aren't going anywhere, but you don't have to become one. If you stick with your long-term mentality, you'll have a competitive advantage over other shareholders that will serve you well.