September 10, 2000 While discussing investments with some friends (I do that a lot), I heard one of my friends (I'll call him John) state that one of his stocks he bought has been in a terrible downward slide for the last year. He had lost over 75% of his original investment capital. I asked, "Why haven't you sold the stock?" John's incredulous reply, "I'm a buy and hold investor. If it goes to zero and I lose all my investment that's the way it goes. I only have a hundred shares." I couldn't believe it! "Buy and Hold" does not mean "Until Death Do Us Part". "Buy and hold" investing still requires taking an active role in your investments. But "buy and hold" to John meant "buy and forget about it". My friend John was violating three of my key principles of investing: - Invest to make money
- Review investments regularly and make necessary adjustments
- Preservation of capital
All of these are interwoven and closely related but each can be discussed individually for illustration purposes. Invest to make money Let's look at the first principle listed above. If you are willing to risk your hard earned money, you need to make your mind up in advance that you are investing to make money – in other words you are serious about your investing. If you aren't willing to take your investing seriously, you should put your money into a bank savings account. A wishy-washy attitude about your investments might lead you to take unnecessary risks and it means you won't be attentive to changes in the "story" of why you chose the investment. The "story" are the reasons why you made the investment in the first place. If you invest to make money then you will be tuned into any changes that might produce negative results and you will be able to react accordingly. Review investments regularly and make necessary adjustments This leads us to the second principle listed. A regular review of the reasons why you made a particular investment is crucial to tracking your progress and whether you are investing to make money or not. Various types of investments will require different time frames for review. At the time of the investment, you should have set some parameters of how long you would wait to achieve these gains. At each review period, you need to reassess the investment to determine your next level of expectant gains and the next time frame to wait to reassess again. If you feel that you still like the performance of your investment and you feel that the future performance of this investment will still meet the objectives that you laid out originally, you will probably want to stick with it. However, if you think that the "story" has changed and you feel your money would be better placed in a different investment, now would be the time to make a change. Of course this all depends on your investment objectives. Preservation of capital The third principle of the list above has to do with exiting a non-performing or a losing investment position. One of the most important reasons to cut your losses as early as possible has to do with the preservation of your investing capital. A very successful investor friend of mine stated that he always cut his losing positions right away so he can preserve his trading capital so he can invest another day. If you lose too much or all of your investing capital, it will severely limit you to the type of investments you could participate in. As you probably know, some mutual funds have minimum opening balance requirements. Also some stocks investments require a cash position and no margining of the stock is allowed. Every investor's risk tolerance is different and needs to be determined by the particular investor's investment objective. Know your exit strategy and determine the price at which you will sell if your investment is losing money. Preserve your capital to invest another day. You hopefully can now see the errors of my friend John's investment strategy. "Buy and hold" investing is one of the best ways to grow your investments over the long term. Two of the many benefits of "buy and hold" investing is the compounding feature and the deferring of taxes. However, the key word here is "GROW". If the investment "story" changes or if you begin to lose money, it might be time to move your money and "divorce" yourself from the investment. Remember "buy and hold" doesn't mean "until death do us part"! |