Why Buy-And-Hold Isn’t All It’s Cracked Up To Be…

A couple of years ago, I had to explain to my Top Stock Advisor premium readers why I decided to color outside the lines with one of our picks…

Normally, our goal is to identify elite businesses that are trading at a discount to their intrinsic value. After that, we buy them and hold for the long haul. In fact, we often cite Warren Buffett’s favorite holding period as our ideal timeline: “forever”.

But this time was different, or so it seemed. You see, this time around the stock we were buying wasn’t necessarily a long-term pick. It was more of an “opportunity” trade — a rare disconnect we spotted in the market that might last anywhere from a few weeks to several months.

But here’s the reality: as I explained to my subscribers, we had actually been doing this for a long time. In fact, I believe these types of trades are essential for any long-term portfolio. Here’s why…

Buy-And-Hold (Alone) Isn’t Going To Cut It

Before I go further, don’t get me wrong… Our “forever” strategy has led to market-beating returns from the vast majority of our holdings. It’s exactly what you should be doing with the majority of your core holdings.

But here’s the part that might get me in trouble…

You see, the unpopular truth about investing is that buying and holding a stock “forever” is unrealistic. In fact, a few years ago, I explained why “buy-and-hold” investing was a fallacy that gets hammered into us by Wall Street and others in mainstream financial circles.

Here’s the truth… Most folks who believe they are buy-and-hold investors end up being “buy and fold” investors. Or perhaps worse, they continue to hold onto a losing position for years — just hoping the stock gets back to their entry price so they can break even.

Holding a losing investment for years is not only an emotional drain. It costs something far more valuable than any return a stock can give you, and that’s time. You can’t make up for the lost time.

And this brings me to my point.

Just like life, time — and timing — can be everything when it comes to investing.

Do You Have The Guts (Or Time) To Weather A Big Drawdown?

If you’re 18 and beginning your investment journey, you can afford to take the occasional lumps that will inevitably come along in the buy-and-hold strategy. If you buy a great company, you have the time to weather the storms and enjoy compounding returns. At that point, it’s just a matter of patience (which is no easy task, by the way).

But many of us do not have that luxury. Depending on your age (or situation in life) you may not have the time to recover from a severe bear market. Just ask the buy-and-hold investors nearing retirement in 2008, when some of the world’s greatest companies saw massive drawdowns. Just remember how long it took for many iconic American companies to recover their previous highs…

For example, American icon Coca-Cola (NYSE: KO) suffered a 40% drawdown during the financial crisis. And it would be nearly three years before shares would recapture their previous highs.

Now, here’s what I want you to think about when you see this chart. Sure, it’s easy to look back and see that if investors held firm during this drawdown that their portfolios would recover… eventually. But would you have been able to hold fast during this period?

The truth is… few people can tolerate those sorts of drawdowns.

Try telling someone nearing retirement that he will have to postpone for a few more years. And that this solid American company will recover eventually. That will be the longest three years of his life.

Just recall how you reacted the last time we had a 10% correction back in September. After living through the Covid-19 selloff in March, did you think to yourself “here we go again…” Now multiply that roller coaster ride times three years. Many of us would (and did) get off the ride altogether.

Even Warren Buffett, arguably the world’s greatest investor, understands that you can’t build a portfolio strictly on long-term, “forever stocks.” When he managed money for other people through the Buffett Partnerships in the 1950s and 1960s, he didn’t put all their money into long-term investments. He doesn’t today, either.

Keep Your “Forever Stocks,” But Do This, Too…

While Buffett is famous for his steadfast patience in many of his holdings — such as Geico, Coca-Cola, and American Express — he also carved out a chunk of his portfolio for opportunities he expected to pay off in a shorter time frame (from a few months to a couple of years).

He also makes sure he has a good chunk of cash on hand to pounce on opportunities as they arise. Buffett’s holding company, Berkshire Hathaway (NYSE: BRK.A) has more than $146 billion in cash.

I believe that these two portfolio characteristics are critically important: 1) dedicating part of your portfolio to investments with a shorter time frame and 2) keeping plenty of “dry powder” on hand.

First, shorter-term investments can provide an added boost to your portfolio and usually have less correlation with the broader market. These are opportunities that are intended to greatly outperform the broader market — sooner, rather than later.​ So you shouldn’t put all your eggs in one basket. (I’m a fan of an 80/20 approach, which I outlined in this article. But your mileage may vary.)

The second advantage of having part of your portfolio dedicated to shorter-term opportunities is that it recycles capital quickly. This allows you to buy elite businesses at a discount to their true value in the event of a market downturn.

This is the classic “blood in the streets” approach that Buffett takes.

Let’s say the market crashes tomorrow (like it did back in March, or even worse). But you know the world isn’t going to end… What would you sell to free up the needed cash to buy wonderful businesses that might be trading at 50% of their true value if your portfolio is filled with only long-term investments? That might be one of the toughest decisions of your investing life.

Action To Take

Look, I want to be clear: I’m not changing the investment philosophy of Top Stock Advisor. In fact, we’ve been doing this as a compliment to our “forever” strategy the whole time.

I will continue to seek out elite companies that we can pick up at fair values. But on occasion, I might color outside the lines. If I see an opportunity in a stock that might not carry the characteristics of a long-term holding but does present an attractive risk-reward setup, I’m going to pull the trigger. And I’m not going to apologize for it, either.

What I will do is be perfectly clear about my intentions. With each of these “speculations,” I will go in with a plan. I will know the downside risk before I go into the investment. I will have a certain downside price threshold that will tell me if my investment thesis is wrong or my timing is off. This will limit my downside risk… because the upside potential is tremendous.

You should consider doing the same.

In fact, if you’re looking for a mix of “home-run” stocks as well as safer long-term picks, then you should check out my premium Top Stock Advisor service.

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