Why Buy And Hold Doesn't Work (For Most Stocks)

We often hear the stock investing advice of 'buy and hold' as though it is a panacea for all investing problems. Such advice also premised on the assumption that 'stocks go up in the long run'.

This can lead investors to mistakenly believe that merely holding onto a stock for an extended period guarantees profitability.

However, this is dangerous advice because there are stocks that don't go up in the long run and may caused losses and missed opportunities for an investor. I believe no one wants to take ten years to find out he has lost money.

In a research titled 'Long-Term Shareholder Returns: Evidence from 64,000 Global Stocks,' led by Hendrik Bessembinder, an extensive analysis encompassing 64,000 global common stocks spanning from 1991 to 2020 revealed a striking revelation. It was observed that the majority, specifically 55.2% of U.S. stocks and 57.4% of non-U.S. stocks, failed to outperform one-month U.S. Treasury bills!

In other words, investors have an higher chance of selecting a stock that will yield poorer returns than a treasury bill over a 30-year timeframe.

Furthermore, in another study overseen by Bessembinder, it was revealed that the most substantial returns are primarily generated by a limited number of stocks. Specifically, a mere 86 stocks have been responsible for generating a staggering $16 trillion in wealth accumulation, constituting half of the total stock market wealth over the past 90 years. This wealth creation can be wholly ascribed to the top-performing thousand stocks, while the remaining 96 percent of stocks collectively matched the returns of one-month Treasury bills.

My own take is that the study's focus on measuring absolute dollar gains may have favored larger-cap stocks. For instance, when a $100 billion company doubles its share price, it contributes significantly to a $100 billion market cap increase, appearing as a substantial wealth generator in the study. Conversely, a stock valued at $100 million that doubles to $200 million would have a smaller impact in absolute dollar terms.

However, from an investor's perspective, both scenarios would have effectively doubled their investment. Therefore, the study would have been more balanced to include measurements of percentage gains and losses for stocks in addition to assessing their absolute dollar contributions to the market.

Top 20 Wealth Creators according to Bessembinder’s Study

Nevertheless, there are three takeaways from this.

First and foremost, the majority of investors would be wise to consider investing in an index fund as opposed to attempting to handpick individual stocks.

Index funds offer a compelling advantage due to their built-in diversification and the inherent tendency to favor the most successful companies based on market capitalization.

Additionally, stocks that experience significant declines in market capitalization are automatically removed from the index, creating a self-regulating mechanism akin to "survival of the fittest."

investors don't need to decide which stocks to buy, how much to buy and what to sell, as the index fund effectively manages all of these aspects.

The second important lesson to glean from this is that if an investor still intends to pursue a buy-and-hold strategy for individual stocks, they must know what to look out for.

Drawing from Bessembinder's research, there are four common characteristics prevalent among the most successful stocks:

1. Robust Cash Accumulation: Stocks with a track record of strong cash accumulation.

2. Rapid Asset Growth: Stocks that have achieved rapid asset growth without relying on mergers and acquisitions.

3. Larger Share Price Drawdowns in the Prior Decade: Interestingly, stocks that have experienced larger share price drawdowns in the preceding decade, although counterintuitive, have been among the top performers. This phenomenon could be linked to the significant drawdowns seen in tech stocks during the Dotcom bubble burst.

4. Higher R&D Spending: Stocks that allocate higher resources to research and development.

It's important to note that these are not foolproof indicators, and the next generation of winning stocks could indeed exhibit a different set of characteristics. Nonetheless, investors can incorporate these indicators on top of the ones they are using.

The third takeaway emphasizes that the majority of stocks are better suited for buying and selling rather than long-term holding. While many stocks may not perform well over extended periods, it's essential to recognize that even the "lower-quality" stocks can outperform in the short to medium term.

This is where certain investment strategies come into play, exploiting short-to-medium-term price fluctuations. Two notable approaches are:

1. Value Investing: This strategy involves buying stocks when their prices are pessimistic, often undervalued, and selling them when prices rebound, potentially capitalizing on price corrections.

2. Momentum Trading: The momentum approach entails riding the wave of increased investor demand for a stock, causing it to trend upward over a period. Investors using this strategy aim to profit from price changes driven by market sentiment.

Hopefully, investors gain insight into the probabilities involved in stock investing and come to realize that success in the markets doesn't solely hinge on luck. One must have the skills to know what to do. Buy and hold doesn't fix investing mistakes.