You are here

If You're Using a Buy-and-Hold Strategy in Your Retirement Account, You Need to Read This

When talking about how successful buy-and-hold investing can be, many advocates of that strategy reference The Coca-Cola Company (NYSE: KO) and point out that buying one share of KO when it went public in 1919 would have turned $40 into $9.8 million. Being a trader, I have of number of reasons to believe that is a ridiculous argument.

First of all, you had to hold your investment for 96 years, which is much longer than the typical investment lifetime of 30 years or so for many individuals. Leaving aside the time frame, the results shown assume that you reinvest dividends. It doesn't seem likely that you could reinvest dividends in 1919 when commissions were high and computers to track fractional shares weren't invented yet. When the time came that you could reinvest dividends, you would have needed sufficient funds to cover the hefty taxes due on the annual dividends. Few people would be able to pay the large tax bills without touching their investment capital.

The bottom line is that the eye-popping gains from KO and other long-term favorites just aren't likely to be obtained by real investors in the real world.

I was reminded of all this when Coca-Cola announced earnings recently but saw slower sales than expected. Not surprisingly, KO moved lower like many stocks that miss estimates do. The rest of the market did better with the major market indexes and most stocks moving up.

The long-term chart of KO below shows that the stock has actually been underperforming the market for more than 14 years.

Coca-Cola Stock Chart

That chart is compressed to show as much time as possible and includes a 20-month moving average (MA) and the Moving Average Convergence/Divergence (MACD) indicator at the bottom. Using these tools, since 1979, a trader could have beaten the results of a long-term investor. Ignoring dividends, the trader would have grown a $10,000 investment to about $480,000, which is about 6% more than a buy-and-hold investor.

Dividends would have added significantly to the gains for both the buy-and-hold investor and the trader, but the trader would only receive dividends while holding the stock. Traders only owned KO for about half the time in the test period.

Risk would have been greater for the buy-and-hold investor who would have seen their account value fall by more than 58% after the 1998 peak in KO. The trader never suffered a decline of more than 25%.

The biggest benefit of trading could be the risk reduction. A loss of 25% hurts, but it would not be as devastating as the loss of nearly 60% would be to someone hoping to retire comfortably.

Reducing risk in long-term holdings can be done with just the two indicators shown on the chart, the 20-month MA and MACD. Use MACD to buy or sell, but confirm all signals with the 20-month MA, which means taking sell signals only when the price is below the 20-month MA and buying only when the price is above the MA. That's all there is to that trading strategy, which can be effectively applied to any stock, even the ones commonly associated with buy and hold.

No company, even Coca-Cola, should be held forever when forever is defined as the lifetime of an individual investor. Trust funds of wealthy families and large endowments associated with charities or universities may be able to benefit from holding periods of 96 years or more, especially given their tax-favored status. Individuals should trade more actively to avoid suffering through a decade or more of long-term underperformance.

Actions to take: Sell any stocks you might be holding, especially ones in your retirement accounts, that are below their 20-month MA and reinvest in stocks that have strong momentum.