>THE DEATH OF THE BUY AND HOLD INVESTOR

The rout experienced by all the world’s equity markets during 2008 will be etched in the memories of share traders and investors for many, many years. Tales will be told, long after the bear market has ended, of fortunes lost and made during this implosion of share prices – stories that will be the repeated at dinner parties and in online chat rooms for years to come.

Many of the stories will be of woe and despair as distraught long-term investors struggled to comprehend and deal with the losses they suffered in their supposedly secure long-term investments. These ‘buy and-hold’ investors have had their portfolios decimated by the events of the Global Financial Crisis and the severity and extent of the current bear market. Many have
watched, frozen in fear and horror, unable to take decisive action as their portfolios halved
in value (in some cases even more) and their retirement plans, via their superannuation
funds, were almost destroyed.

Those who placed their faith in, or abdicated their financial responsibilities to, fund managers, financial advisers, or other so-called experts are even worse off, because fees and commissions are still being drained from their accounts – even though the investments have suffered
massive losses.

The buy-and-hold strategy employed by many equity investors and ‘traders’, which appeared to be working quite nicely during the extended bull market up to the latter stages of 2007, has proved disastrous as the market has collapsed. Many people have been left holding stocks that have become virtually worthless – for example, Royal Bank of Scotland (figure 1) and Citigroup (figure 2). Others, with holdings in the likes of ABC Learning (figure 3) and Centro Properties, have seen their investments completely wiped out.

What is value?
Even blue-chip companies, like the major banks and others in the Top 20, have seen their share prices savaged by the extended bear market. Whilst there may be an argument that these prices are cheap, represent great value, or represent ‘great buying at these levels’, three questions need to be asked. First, how do you know they are cheap? Second, what’s to stop them becoming even cheaper? Finally, who says they are cheap?

If the answer to that last question is the same person or organisation that advised you to buy them in the first place, and then either told you to hang on and wait for the prices to turn around, or, worse still, encouraged you to participate in that age-old furphy of averaging down and buying more as prices continued to fall (to reduce your average cost), then it might be about time to consider a new approach to your engagement with the share market. A cursory glance at just about any share price chart at the moment will show you just how ridiculous this strategy is. See the charts for Royal Bank of Scotland, Citigroup, and ABC Learning – stocks that were being advocated as cheap by certain experts and advisers, all the way down.

It remains to be seen whether those who are averaging down will live long enough to experience any gain from reducing their average price, given the massive price corrections experienced by nearly all stocks.

Waiting for the bounce… and still waiting
Mary had been steadily accumulating shares in Macquarie Bank (MQG) (figure 4) from early 2000. She had built a sizeable holding that was worth a considerable sum of money at the values reached in mid 2007, when the race was on to see if Macquarie could make it to $100.00 per share. Mary watched with alarm when the price dropped suddenly from just over $98.00 per share in May 2007 to around $66.00 in mid August. Her husband and financial adviser convinced her to hang onto the shares. He thought it was only a short-term correction and that Macquarie would turn around and continue its upward move through and then well beyond $100.00.

Turbo charging the crash
Many losses have been exacerbated through the effects of over-geared and over-leveraged accounts. Many uneducated and unprepared market participants were using margin loans and highly leveraged instruments to ‘gear up’ their exposure to the share market. Spurred on by stories of the never-ending bull market, the commodity super cycle, and the China effect, these people were throwing money into the market on a whim in order to be part of the action, and make their fortune share trading ‘in as little as one hour a day’. Unfortunately, they had no real idea of what they were doing. Nor did they have an understanding of the concepts of risk management and money management. Over exposure, lack of a trading plan, and disdain for money-management concepts wreaked havoc when the market crashed. Cash margin calls, the forced sale of shares, and in some cases other assets, to meet margin calls added more fuel to an already raging inferno.

Know when to hold ‘em… know when to fold ‘em
A major problem with a buy-and-hold strategy is knowing which ones to throw away (and when), and which ones to keep. In hindsight it’s all crystal clear. ‘If only I’d sold ABC and held XYZ,’ is a common lament. Whilst holding some stocks for the really, really long term may well prove beneficial for those with exceptionally long time spans, perhaps generations, for most share market participants it is not a successful strategy because it simply doesn’t work.

Actively managing your share portfolio – cutting losing trades, knowing where and when to exit profitable trades, understanding money-management and position-sizing techniques – is the only way to ensure success in any market. Share prices may recover over the long term but how long will it take? How long will it be, for example, before we see RIO back to $160.00 a share?

Hedging your bets
Portfolio hedging has allowed those who know how to use it to offset losses incurred in their long-term portfolios with profits made from their hedging activities. By short selling index CFDs and equity index futures, and by using put options and warrants, these investors have been able to weather the storm to a much greater degree. This is a much more fluid approach than simply sitting on the sidelines waiting for things to get better. It takes time, effort, a detailed trading plan, and a knowledge and understanding of the various instruments available to use for hedging for its effective and profitable use. The effort required is more than rewarded, however, if losses of profit and capital can be minimised.

To see full report: THE DEATH OF THE BUY AND HOLD INVESTOR