Buy and Hold Forever Is Bad Advice

We've all heard it before. BUY AND HOLD FOREVER. It seems like such a simple strategy with some amazing success stories. With people like Warren Buffett (the world's best known investor) praising the buy and hold forever strategy, its no wonder so many people follow it. As easy as it is, it isn't without flaws. I admit this even though I'm primarily a buy and hold investlr.

The Pro of Buy and Hold Forever (Hint: Think Compound Interest + Taxes)

Before I get to the flaws, I want to mention one of the pros of the buy and hold forever. When you buy a stock and sell it after it has appreciated, you have to pay capital gains taxes. If you don't sell it you don't pay any taxes. Let's set an example up to show how important this aspect can amount to.

Example: Let's say you bought a stock and held it for one year and sold it at the end of a year, and you repeat this exact same cycle for 35 years (selling the stock once a year). Each year before you sell the stock it goes up in value by 10% and your starting portfolio is $50,000; and lets say your taxes are 40%. At the end of 35 years your account value would be $384,304 and you would have paid $222,869 in taxes over the years (if you add those up, that equals $607,173). If you would have held one stock the entire 35 years and had the same 10% annual appreciation it would be worth $1,405,121!

Yup, the power of compound interest never ceases to amaze me when I do the math. I guess it pays to think about the compound interest on money that you pay in taxes as well! I think far too many people forget that. It gets even more important if you factor in dividend yields. If the stock starts paying a 4% dividend in year 35, the guy that trades a lot and now has an account value of $384,304 will only earn $15,372; Compare that with the guy that held the stock for the entire time and has an account value of $1,405,121 and now earns $56,204 in dividends.

This should illustrate why I like a buy and hold strategy (if you start making too many trades you get brokers and the tax system involved more than they need to be). I LIKE BUY AND HOLD… but “Forever” depends on the company and the situations.

Buy and Hold For a While

A better strategy would be called “Buy and Hold as long as the company is fundamentally strong and the money can't be better employed elsewhere.” When you say “Buy and Hold Forever”, too many people will take that advice at face value and will hold on to companies that are going through severe problems and perhaps on their way to bankruptcy. It's so crucial to discern the two strategies have differences. Why continue to hold a company that is now only growing at 1% a year(lower than inflation) or shrinking when you can invest in another company that has much better fundamentals? It wouldn't make economical sense to do so.

So, Buy and Hold For As Long as a Company Is Fundamentally Strong and the Money Can't Be Better Employed Elsewhere. At least that makes more economical sense to me.