Avoiding the 3 Pitfalls of 'Buy & Hold' Investing
Rumors of the demise of 'buy & hold' investing are greatly exaggerated. This strategy is as relevant today as ever, but there are several traps that need to be avoided....
Rumors of the demise of 'buy & hold' investing are greatly exaggerated, to say the least.
Purveyors of market timing would like us to believe that this investment strategy is no longer relevant to the pandemic-dominated market environment.
Stocks have continued to push higher in the face of various challenges, ranging from newer and more virulent Covid strains to supply-chain challenges and inflationary pressures. Even the Fed’s changed posture has not been able to weigh on sentiment negatively, taking most of the major indexes to near record levels.
The resulting stock market investing experience for the thousands of new investors that entered the market during the pandemic has been nothing short of heady. With this all-around sentiment positivity lifting most stock market boats, investors are at risk of reaching the wrong conclusions from their recent success and discarding long-held investing beliefs, including the virtues of ‘buy & hold’ investing strategies, as no longer relevant.
It is important to remember that long-term investing, particularly a 'buy & hold' approach, remains as relevant today as it has ever been. And notwithstanding naysayers' claims to the contrary, empirical evidence continues to show the long-term superiority of a 'buy & hold' strategy over any other investing approach.
But to adequately benefit from this tested and proven strategy, investors need to guard against three major pitfalls. Here they are:
1) 'Buy & Hold' Doesn't Mean 'Buy & Forget'
Staying engaged with your portfolio is a must. Investing for the long run doesn't mean that you lose sight of developments in your portfolio. The 'buy & forget' mantra is a simplified take on the typically long holding horizons of investment icons such as Warren Buffett.
Buffett may be in the habit of keeping his investments for the long term, but he stays fully tuned into what's happening in each of his holdings. While the Oracle of Omaha is no doubt one of the most successful and famous exponents of the 'buy & hold' investing approach, he is by no means the only one. All of the successful practitioners of this approach stay well informed of what is going on with each of their holdings to make sure that the primary reason(s) why they picked the stock(s) was still valid. This helps them avoid unnecessary changes.
Let me give you an example from the Top 10 Stocks for 2021 portfolio that follows a calendar year ‘buy & hold’ strategy. The portfolio did extremely well, outperforming the broader market more than 9 percentage points through December 10th. But one of the 10 stocks, Macy’s (M), lost more than a quarter of its value over a one-week period in mid-March 2021.
I didn’t ignore the sell off, but my due diligence convinced me that the weakness was nothing more than elevated market jitters about a vulnerable operator in a weak industry, but our long-term thesis still remained intact. Our level-headedness paid off, with the stock up close to +150% through December 10th. WillScot (WSC), another Top 10 for 2021 stock, suffered a roughly 15% drop in the second half of January 2021, but eventually recovered and will end the year up in excess of +70%.
More . . .
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2) Don't Fall for the 'Buy What You Know' Mantra
Guard against the simplistic beauty of the 'buy what you know' mantra; another one of those skin-deep lessons learned from Warren Buffett's investment style.
Adherents of this 'philosophy' load up on stocks from a bunch of companies whose products they use. And then they keep those stocks forever, a la Buffett who has famously hung onto his investment holdings for years.
Being familiar with a company's product(s) is a useful, but not necessary, starting point to 'knowing' the stock as an investment opportunity. The decision to buy the company's stock should follow a thorough, due diligence process that gives you a solid appreciation of the company's prospects, competitive position and the proper value of its stock.
Let me give you the example of Quanta Services (PWR), a stock that we picked for the Top 10 for 2021 portfolio. Most of us would never come across this electric utility builder, but that didn’t mean I couldn’t evaluate the company as an investment opportunity. The stock became a big success, up more than +60%, given its leverage to infrastructure spending and growing exposure renewal energy and EV charging stations. We envisioned Quanta benefiting from fresh infrastructure spending that we expected would come through as a result of the Biden administration’s plans. But we were confident that Quanta could thrive even if the hoped for legislation fails to get Congressional support.
Zebra Technologies (ZBRA) is another example from the 2021 portfolio that proved to be a strong performer, up more than +50%, but this maker of thermal bar printers, bar code scanners and other business mobile computing solutions is hardly a household name.
Studies show that people have a crippling blind spot when it comes to stocks that they think they know. Too often they will overlook the negatives of the firm because they have fallen in love with the stock. Love is nice in your personal life, but there is no place for passion and emotions while evaluating stocks.
3) Stick With a Plan
Avoid haphazardly or randomly filling your portfolio with stocks you like. Always build your portfolio around an investment outlook and stay ready to make adjustments should that outlook change.
I am not suggesting that you need to have an elaborate and explicit outlook for GDP growth in the next quarter or year, but you absolutely need to have a base-case sense for the economy and the market.
If you expect a major economic downturn in the coming 12 - 18 months, your choice of investments would be very different from someone looking forward to a goldilocks-type scenario.
The vaccination exercise had just gotten underway as we put together the Top 10 Stocks for 2021 portfolio. We expected the pandemic to remain part of our lives, with the vaccines allowing some measure of normalcy to return. We had a favorable outlook for consumer spending, corporate profits, interest rates and the broader economy. We picked off-the-radar stocks for the portfolio that came from diverse parts of the market, but enjoyed unique competitive advantages in their respective spaces that promised multi-year growth trajectories.
Many expected Macy’s to fall victim to the pandemic and saw value only in the company’s real-estate assets, but we had greater confidence in the company’s digital strategy that we saw benefiting from a spending rebound. The Quanta and WillScot picks were infrastructure plays, with many others similarly picked for leverage to specific themes or expected trends.
And you must stay nimble and flexible enough to adjust your positions should your outlook change.
Putting It All Together
Please keep each of these pitfalls in mind while putting together your stock portfolio to increase your odds of success. We do the same in our annual 'buy & hold' portfolio that we create and maintain every year. We call it Zacks Top 10 Stocks, a portfolio featuring 10 stocks that I personally select and then actively monitor on your behalf. We are about to come out with Zacks Top 10 Stocks for 2022.
We construct this portfolio by first taking a look at the economic and earnings outlook. Then we narrow in on the industries that we believe will outperform and stay away from the others. From there, we use our proprietary stock-rating system to help select the best stocks in those favorable groups.
This stock selection process has stood the test of time, producing strong returns in good times and bad. Since 2012 when I started managing this service, the Top 10 portfolios nearly tripled the S&P 500. While the market gained +329.4%, Zacks Top 10 Stocks skyrocketed +962.5%.¹ And the 2021 portfolio substantially outperformed the very bullish S&P 500.
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The New Year brings a host of challenges and opportunities for the investing public. But rest assured that the stocks we have picked for 2022 fully take into account what lies ahead.
Remember, since 2012, Zacks’ forward-looking analysis and careful monitoring has enabled our Top 10s to nearly triple the S&P 500 index.¹
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Sheraz Mian is Zacks’ Director of Research, and determines the most valuable data to use for assessing winning stocks and funds. He is a contributor for Zacks Equity Research and Earnings Analysis, and since 2012 has personally handpicked Zacks Top 10 Stocks.
¹ As of market close 11/30/2021. The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.
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