Investing

Buy and Hold or Active Investing: Which Is Better for New Investors?

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The generation of investors getting started today has some big advantages over those of us who began our journey decades ago. They can buy and sell without incurring fees that equate to a big percentage of their investable cash, for one thing, and they also have ready access to a wealth of information, from raw data to advice and opinions. That, however, is a bit of a double edged sword.

Back in the day, investing at least had the advantage of simplicity. With such large fees and no practical way of tracking performance other than looking at closing prices in the next day’s newspaper, buy and hold was really the only option available to almost all retail investors. Now, if anything, there is pressure to go the other way, to trade actively, even when “set it and forget it” would probably be a better option. Everything on the major financial TV networks and social media is geared to the short-term, with traders rather than long-term investors being the day-to-day stars.

That leads to a lot of people trying to time the market, and a lot of exaggerated expectations. They think that if something is in profit, they have to sell before the market drops, and that the only time to buy is after a twenty percent or so decline. They look back and realize that doing that would have netted profits of fifty percent or whatever over the last year and believe that that is what they should be aiming for. Of course, logically, hitting the exact tops and bottoms of moves in order to achieve that is just about impossible, and trying to do it usually leads to the frustration of missed opportunity, or actual losses.

So, which is it? Should investors take advantage of all the available information and take an active approach to managing their portfolio, or should they trust the buy and hold method that has proven more effective over time? It is something that is particularly relevant now, with stocks posting significant gains in the first half of the year, despite some well-publicized risks and headlines.

Unfortunately, there is no one simple answer to that question, but the best, most practical approach is usually a bit of both. If you feel the need or desire to be active in some way, then understand that and have a separate, small account for trading, but keep the bulk of your funds invested in stocks or funds with a long-term bias. In your short-term trading account, set parameters for every trade and stick to them, taking a profit or loss when they are hit, regardless of what you may feel at that time. In that longer-term account, though, even if the aim is to buy and hold, it is possible to use the availability of information and ease of trading to your advantage.

I call this strategy a “rolling reassessment,” whereby you set levels, both above and below a stock’s current price, at which you re-evaluate your holdings. That re-evaluation involves looking at the fundamentals and prospects of the stock again. Has the company been performing as you expected? Is the investment thesis that led you to buy in the first place still valid? In short, if you didn’t own it already, would you buy it now? If the answer is yes, sit tight. If not, consider taking a profit -- or loss if that is the case -- on at least a portion of your position. Then invest that money in something with better prospects over the next year or so. Your bias, however, should always be towards holding, and selling should only be done when something looks seriously overvalued.

Having a plan to do that enables you to do the most important thing in the modern, media-driven world of investing: cut out the noise. You will get in the habit of evaluating a stock on what truly matters, the fundamentals of a company, and will be less tempted to buy the latest hot thing just before it cools down. On the other hand, it makes it less likely that you will just sit and watch when a stock with big gains goes out of favor, or the conditions that pushed it higher change and it retreats sharply.

The main point here is to invest and manage your investments intentionally. Make sure you understand that trading and investing are two different things and that positions taken with a view to trading must be managed differently to your investments. Understand too that you have an advantage over previous generations that makes it possible to make informed decisions about long-term holdings, and don’t be afraid to trust your analysis and sometimes take at least a partial profit or loss when the situation calls for it. Even if you do those two things, there is no guarantee that you will be successful but, if you do, you will increase the chances of success considerably.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

Read Martin's Bio