Holding investments does not help

Your strategy should be tweaked for different market conditions and different stocks.

There are good chances that you financial planner advises you to buy and hold your investments. Reason: This helps in wealth creation over the long-term, specially for individual investors or retail investors. And across asset classes.

But, in recent times though the market has fallen (25 per cent), it has seen many swings and a lot of volatility. This has led to shorter bull cycles or stock market run up. For instance, we saw a poor market run between 2001 and 2003. Then we saw a bull run from 2004 to 2007 and the market started falling in 2008. The market then recovered in 2009 and started falling late-2010. This has resulted in many investors doubting the buy and hold theory.

REVIEW INVESTMENT STRATEGY IN VOLATILE MARKETS
	31-Dec-08	29-Dec-06	31-Dec-01
S&P Nifty: December 30, 2011 - 4624.3
Index Level	2959.15	3966.4	1059.05
Holding Period	3 years	5 years	10 years
Absolute Return (%)	56	17	337
Simple Annual Return (%)	19	3	34
SBI: December 30, 2011 - Rs 1,628.85
Stock Price (Rs)	1291.7	1235.55	175
Holding Period	3 years	5 years	10 years
Absolute Return (%)	26	32	831
Simple Annual Return (%)	9	6	83

 

In a buy and hold investment strategy you don’t trade around positions, regardless of the market fluctuations. Simply put, you are not concerned with short-term market / price fluctuations and micro / macro economic conditions. The fundamental assumption behind a buy and hold investor is that the market will only gain in the long-term and will help the investor to catch the general upward movement in stocks. Most famous value investor Rakesh Jhunjhunwala has successfully adopted this theory and made money.

The recent volatility in the stock market and lack of direction has resulted in doubts in minds of investors whether the buy and hold theory still persists. Some data has been tabulated alongside about the National Stock Exchange’s 50-stock index or Nifty levels and State Bank of India (SBI) stock prices.

As can be seen from above data, the returns for the ten-year period is good for both the Nifty and SBI. This is the period during which India’s growth story got recognised. In fact SBI has outperformed the Nifty during the period. However, the returns for the 5-year period is low for both. They will not cover the inflation in the economy. The 3-year period returns are moderate. If we try to analyse some intervening periods such as a four or two-year period, it is in fact negative. If we try to analyse the above, it is clear that when India’s economy was integrating with the global economy, the market was generating above average returns. But off late, with a lot of economic development, the growth in market has moderated.

Now let us look at times when buy and hold theory works-  

 

 

The basic premise this theory works on is that the markets go up in the long-term, which holds true in a secular bull market, that is, when the bullish conditions prevail for a longer time. Although there exists some volatility in a bull market, since volatility isn’t that high as compared to that of a bear market, buying and holding enables one to generate good returns.
 

It only works if you make a firm resolve to hold in any scenario. Applying this investment strategy requires one to hold onto stocks when the going gets tough (stock market falls, there is panic among investors and so on). Many buy and hold investors lose the courage to hold and sell their investment when they should have held and waited out the crisis. As long as you stay in control of your emotions, and avoid the noise around you, holding onto stocks even during market crashes shouldn’t be a problem.
 

It also works well if you have sufficient liquidity, have the ability to hold the investment for the long duration.

But then, there are times when this strategy doesn’t work - 

It doesn’t work in a bear market. A secular bear market is the opposite of a secular bull market. If you buy and hold during these periods, you will have noticed that your portfolio has not increased in value, where as the general inflation may eat away at your hard earned savings. Buying and holding during a secular bear market just doesn’t work, because one will be holding onto an investment that will generate zero investment returns for many years until the secular bear market is over.
 

One should not apply the buy and hold strategy to the stocks in the commodities segment such as cement, metals, steel and so on. The stocks in this industry are influenced by the cyclical fluctuation in the industry and usually do not generate wealth in the long-term due to the cyclical ups and down.

Although we cannot discard the buy and hold strategy completely, even in the current scenario, it will be advisable that the investors apply the same fundamentally sound stocks with a proven track record like most large-caps. The stocks in the mid- and small-cap segment may be churned based on market opportunity to preserve your capital invested.

A smart investor must realise that there is no single investment strategy that works in all market conditions. If you stick to an investment strategy such as buy and hold in all market conditions, there is a likelihood that you erode your wealth. It is important to be judicious and take expert help on when it may work for you and when it may not.

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The writer is a freelancer.