The essence of buy-and-hold investing is this: identify high-quality companies with compelling growth prospects and current market values that are low relative to the companies’ underlying economic value. Acquire shares selectively and hold them for long periods of time, which could mean decades or possibly forever. This minimizes transaction costs–a major liability in market-timing strategies–and allows investors to share the benefits of companies’ long-term growth. It has an elegant simplicity: no trading, no capital-gains taxes, no worries.
That doesn’t mean buy and hold is risk-free. In this last bull market, many investors were drawn to the alluring growth prospects offered by various companies in the technology sector. Combining buy and hold with a technology emphasis came to be seen as the fast lane to stock-market riches.
The central challenge of long-term investing is that the underlying companies are always changing, some more rapidly than others. No sector changes as much as technology. Popular catchphrases such as “creative destruction,” “discontinuous change,” “inflection points” and “paradigm shifts” all attest to the volatile nature of technology-driven businesses.
Not a few buy-and-hold investors have wrecked their portfolios on unforeseen shoals along the rocky tech shoreline in recent months. How exactly did this come about? And how does an investor look beyond the current gyrations of today’s market and find the strength to buy and hold a stock, particularly a tech stock? These are the questions investors have uppermost in their minds today.
A fundamental and enduring advantage of the buy-and-hold approach compared with other investing strategies is its long track record of superior returns. But experience shows that buy and hold works best with companies that are resistant to change, or at least those that don’t change anywhere nearly as rapidly as the modern-day tech company.
For instance, the sneaker company Nike was a fantastic buy-and-hold investment during the great bull market of the 1980s and 1990s. From the end of 1984 to the end of 1996, the Dow Jones industrial average increased fivefold. But over the same span, Nike’s stock price rose more than 60-fold. A buy-and-hold investor would have crushed the market with Nike.
And if Nike wasn’t to your liking, you could have bought its archrival, Reebok, and still done well. Reebok shares advanced ninefold between 1985 and 1996, a slightly shorter holding period than our Nike example. Again, that performance dusted the Dow’s overall return. The upshot from the Nike and Reebok examples, as well as dozens of other long-term winners over the years, is that investors are ultimately rewarded for hanging on to good stocks.
Then again, holding on to the same stock for 11 or 12 years is a lot easier said than done. You have to ride the stock down as well as up. Despite Nike’s long-run ascendancy, there were no less than four different years between 1984 and 1996 when its share price dropped by 40 percent or more. In other words, every third year it took nerves of steel for Nike shareholders to hold on. Likewise, Reebok’s stock price ended the year lower than it started in four years of our 11-year holding period, including a 39 percent crash in 1990.
Such volatility applies to tech companies as well, as many investors have discovered in recent months. Hewlett-Packard and Intel are long-standing technology leaders with impressive track records of adapting to different business environments. But even they have experienced market turbulence. In fact, both Intel and HP endured a four-year stretch between 1982 and 1986 when the average annual returns from their stock prices were no better than the rate of return for a typical savings account. Over time, though, this period of nonperformance became less meaningful for the HP and Intel investors who nonetheless hung on. Both stocks went on to outperform the Dow over the ensuing 10 years, Intel by a resounding 15-to-1 margin.
Still, risk remains a central element even for buy-and-hold investors. It’s easy to overlook when reflecting on historical examples. Likewise, it’s often given short shrift when investors peer into the future in an area like technology, where the eye-popping growth prospects can mask the stomach-turning potential for wild moves in short-term market pricing.
There is no way for buy-and-hold investors to fully defend themselves from the inherent risks associated with investing or the stock-price volatility that will regularly crop up in the market. This is as true for investments in New Economy stocks as it is for “shoe economy” stocks. But history shows that buy and hold does work, as long as the investor confronts the risks involved and is realistic from the outset. Nothing ever climbs in a straight line.
