Three Pitfalls of Buy-and-Hold Investing

Rumors of the demise of buy-and-hold investing are greatly exaggerated, to say the least. But to adequately benefit from this tested and proven strategy, investors need to guard against three major pitfalls.

This article was originally published by Zacks.com.

Rumors of the demise of buy-and-hold investing are greatly exaggerated, to say the least.

Purveyors of market timing would like us to believe that this investment strategy is no longer relevant to the current uncertain environment. The crash of 2008 and the market's sub-par returns over the last decade have made investors question many of their long-held beliefs, including the virtues of buy-and-hold strategies. This shows up in weak money flows into equity mutual funds, which have yet to fully reverse despite the market's strong gains in the last three years.

But long-term investing, particularly a buy-and-hold approach, remains as relevant today as it ever has been. And notwithstanding naysayers' claims to the contrary, empirical evidence continues to show the long-term superiority of a buy-and-hold strategy over any other investing approach.

But to adequately benefit from this tested and proven strategy, investors need to guard against three major pitfalls.

'Buy and hold' doesn't mean 'buy and forget'

Staying engaged with your portfolio is a must. Investing for the long run doesn't mean that you lose sight of developments in your portfolio. The buy-and-forget mantra is a simplified take on the typically long holding horizons of investment icons such as Warren Buffett.

Buffett may be in the habit of keeping his investments for the long term, but he stays fully tuned into what's happening in each of his holdings. While the Oracle of Omaha is no doubt one of the most successful and famous exponents of the buy-and-hold investing approach, he is by no means the only one. All of the successful practitioners of this approach stay well informed of what is going on with each of their holdings.

Don't fall for the 'buy what you know' mantra

Guard against the simplistic beauty of the “buy what you know” mantra; another one of those skin-deep lessons learned from Warren Buffett's investment style.

Adherents of this “philosophy” load up on stocks from a bunch of companies whose products they use. And then they keep those stocks forever, a la Buffett who has famously hung onto his investment holdings for years.

Being familiar with a company's product(s) is a useful, but not necessary, starting point to knowing it as an investment opportunity. The decision to buy the company's stock should follow a thorough, due diligence process that gives you a solid appreciation of the company's prospects, competitive position and the proper value of its stock.

In fact, studies show that people have a crippling blind spot when it comes to stocks that they think they know. Too often they will overlook the negatives of the firm because they have fallen in love with the stock. Love is nice in your personal life, but there is no place for passion and emotions while evaluating stocks.

Stick with a plan

Avoid haphazardly or randomly filling your portfolio with stocks you like. Always build your portfolio around an investment outlook and stay ready to make adjustments should that outlook change.

I am not suggesting here that you need to have an elaborate and explicit outlook for GDP growth in the next quarter or year, but you absolutely need to have a base-case sense for the economy and the markets.

If you expect a major economic downturn in the coming 12 to 18 months, your choice of investments would be very different from someone looking forward to a goldilocks-type scenario.

And you must stay nimble and flexible enough to adjust your positions should your outlook change.

Sheraz Mian is the Director of Research for Zacks and manages our award-winning Focus List portfolio. He is among the experts whose recommendations appear in Zacks Confidential.

The information supplied above by Zacks Investment Research Inc. contains opinions based on factual research which may or may not be accurate. Neither Zacks nor Intellisphere will assume any liability for losses from investment decisions based on this information.

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