The buy-and-hold
is the most commonly used investment strategy.
Many investors choose this method because of its simplicity: buying a
stock and holding onto it, no matter how much the share price rises or falls.
Buy-and-hold investors usually sell their stocks only when they have
reached a certain goal such as making enough money for retirement, a college
fund, or a house. Investors can buy
a stock, hold onto it, and not have to worry about the right time to sell.
Because you do little with the stock, the buy-and-hold method requires
few transaction fees. Also, you can
build up your wealth and pay a lower rate of capital gains taxes.
Now, you
may be wondering whether this approach works.
In a year, the chances for a huge drop in a share price are quite high
but the longer you hold onto a stock, the chances of the share price being lower
than what you paid are very slim. A
study by professor Roger Ibbotson with a consulting firm in Chicago concluded
that from 1926 to 1999, the average
compound return
on the stock market was about 11.2% per year.
If you hold a stock for more than 10 years, your stock performance will
be much closer to these historical annual returns.
But if you hold a stock for less than a year, the chance for you to lose
money in the stock market is very high, especially if you invest in a falling
market.
The key
to using this method is patience. Some
stocks will have real gains many years after you buy it.
So, if you need retirement money in a couple of years, holding a stock
regardless of its value may not be your best bet.
Whether buy-and-hold works for you depends on the amount of time before
you need to cash in on your invested money.
A good start is ten years but if you don’t have that much time, the
buy-and-hold technique can be risky.
Sometimes,
using other investment strategies can be more profitable if you catch the market
in a slump. Using the
buy-and-hold strategy, the
gains over a long period of time may amount to a small percentage, and inflation
can take away any profits at all.
Also, many buy-and-hold statistics show only a certain period of time
when the method was extremely effective.
The best results will depend on your time span.
If you buy a stock for a child at a young age and hold onto it until he
or she goes to college, you will have more than enough money for college
expenses. The
buy-and-hold strategy depends on your investing style, but it is the simplest to
do.
The
exact opposite of the buy-and-hold is short-term
trading.
As the name suggests, short-term traders often hold a stock for only a
few months, weeks, or even days.Short-term
traders believe that they can make more money from trading frequently rather
than buying a stock and holding onto it for over 10 years.
Here’s
how short-term trading works: you decide to buy 100 shares of AOL at $60 per
share, a $6,000 value. A week
later, you sell your shares at $54, a $5,400 value.
When the stock reaches a low of $30, you use your $5,400 and purchase 170
shares of AOL. The share price then
increases to $70, and you sell for a $6,800 profit. Using the buy-and-hold, if you had bought 100 shares at $60
and waited until the share price went up to $70, your investment would be worth
$7,000, only a $1,000 profit. Even
though the short-term traders had to pay more commission, the net gains can
sometimes be higher compared to buy-and-hold investors.
The
strategy of short-term traders is to set a target price to buy or to sell. If they think the price will increase, they will usually set
a goal and sell the stock when it reaches that price. However, if the share price decreases, the short-term traders
usually sell the stock quickly. They
hope to make a respectable profit on the stocks they guessed correctly and lose
as little as possible on the stocks they guessed incorrectly.
Clearly,
to follow their buy and sell strategies, short-term trading requires a lot of
discipline. For example, if the
share price drops, a short-term investor may not want to sell for a loss and
will wait in hopes that the share price will rise.
Instead, the price could drop even lower, producing even more losses.
Similarly, if the share price increases, a short-term trader may get
greedy, holding onto the stock thinking that it will rise even higher.
The share price may indeed rise more, but it could also drop below that
investor’s goal price. The
investor may wait for the stock to climb back to the goal price, but the stock's
price could also keep falling. In
both cases, short-term investors are also practicing the buy-and-hold.
By failing to commit to one method, they can reduce potential gains.
Many short-term investors suffer from lack of discipline.
To try
to be in and out of the stock market at the right time, short-term traders try
to time the market. They base their
decisions on the performance of the market, but when was the last time someone
could consistently predict whether the market was going to go up or down?
Almost every financial advisor says it’s impossible to time the market,
but many short-term investors still use market-timing strategies to improve
their chances of buying and selling for the largest profit and the smallest
loss.
Many
people wonder what they could do with the $100 they normally save each month. One option is to use the money to participate in a company’s
Direct
Investment Plan
(DRIP). It allows you to buy shares
directly from a company without paying commission.
Starting a direct investment plan with a company is very simple and can
have many advantages for investors not having a lot of time or money.
Some
companies such as Wal-Mart, Lucent, Exxon, and Fannie Mae will let you buy
direct without paying commission. On
the other hand, companies such as Intel and Coke require you to own at least one
share, making you a shareholder and part owner of the company, before joining
the direct investment plan. Acquiring
the first share can be done in several ways:
You can be given a share.
You can buy a share from a discount
broker,
who usually charges less than $10 commissions. The stock must be registered in your name, not in a street
name
.
You can buy a share through The
National Association of Investors Corporation (NAIC), an investment club
organization.
You can buy a share through Web sites
like Firstshare.com.
With
your $100 savings every month, you could continue putting that money into a DRIP
to buy more shares since most companies on a regular basis offer Optional
Cash Purchases
(OCPs), which allows money from your checking account to be automatically
deducted to buy more share and required little or no commission.
Direct
investing has many benefits, mainly that it requires little money to join a
company’s DRIP. You need to put
aside only $50 or $100 from your paycheck in a DRIP that includes no commission. In addition, direct investment allows you to buy shares with
a method called dollar-cost averaging.Because you invest the same amount but at different share prices, you
will be able to buy more shares at the lower share price.
Therefore, your average will be closer to the lower share price.
Unfortunately,
direct investing can have several drawbacks.
First of all, direct investing doesn’t help diversify your portfolio.
Your $50 or $100 will be able to participate in only one direct
investment plan, meaning being able to buy shares in only one company.
One option to get diversified is to invest in the direct investment plan
for mutual funds or index funds. Some
index funds will allow you to invest $50/month in their plan. Index funds don’t require brokerage fees but have a higher
cost than stocks because of the management fee.
Direct
investing can also amount to piles of paperwork.
With direct investing, you are buying shares every month.
Keeping track of the costs can be tedious.
In addition, buying and selling the shares of stock may be slower than
standard buying and selling. Some
companies will allow you to buy and sell only once a month, which can be
attractive to long-term investors who don’t plan to sell often.
DRIPs
can also stand for dividend reinvestment plan, meaning your dividends can be
automatically reinvested to buy additional shares of the company without a fee.
In order to have your dividends reinvested, you simply check a box and
the company will enroll you in the DRIP.
Before
the Internet age, brokers charged around $50 to $150 for each stock trade.
Then, direct investing became an ideal solution for investors having only
$50 or $100 in savings each month.
But now, when brokers are charging as little as $2 per transaction,
direct investing seems less beneficial in cost savings.You also lose flexibility to buy and sell compared to making transactions
online at anytime with low cost. BUYandHOLD.com
and ShareBuilder.com are two of the Web
sites that let you buy fractions of shares at low
commissions. Nevertheless,
direct investing saves commission and forces people
to put money aside for investing on a regular basis.
Investors
often wonder whether they have missed the right opportunity to get into the
stock market. If you think the
chance has passed you by, dollar-cost averaging (DCA) is the perfect solution.
When
investing, you can either invest a lump
sum
or dollar-cost average. With a lump sum, you invest a large amount of money at one
time in a stock. However, investing
a lump sum requires good market timing. When
you dollar-cost average you put a certain amount of money, such as $50 or $100,
into an investment on a regular basis regardless of the share price.
|
Month |
Amount Invested |
Share Price |
# Shares Bought |
| January |
$100 |
$20 |
5.00 |
| February |
$100 |
$18 |
5.56 |
| March |
$100 |
$16 |
6.25 |
| April |
$100 |
$14 |
7.15 |
| May |
$100 |
$12 |
8.33 |
| June |
$100 |
$10 |
10.00 |
| July |
$100 |
$10 |
10.00 |
| August |
$100 |
$12 |
8.33 |
| September |
$100 |
$14 |
7.15 |
| October |
$100 |
$16 |
6.25 |
| November |
$100 |
$18 |
5.56 |
| December |
$100 |
$20 |
5.00 |
| Total |
$1,200.00 |
|
84.58 |
|
Average Cost Per Share: $1,200 / 84.58 = $14.19 |
In
the above table, you can see that when using dollar-cost averaging, you have to
pay only $14.19 per share as opposed to someone investing a lump sum, who would
have to pay $20 per share.
Most investors want to buy low and sell high.
However, they tend to do the opposite.
They usually buy in a rising market and sell in a falling market.
Dollar-cost averaging will take away the need to time the market.
With
dollar-cost averaging, your average price per share will be toward the lower
side in the long run. It is good
for small amounts of money, such as $50 or $100.
When you dollar-cost average, you will be able to buy more shares at a
lower share price:
In
the long run, your cost will be closer to the lower share price because you were
able to buy more shares at a lower price and fewer shares at a higher price.
Investors
can start dollar-cost averaging with a 401(k) plan or an automatic
investing plan
(AIP). You can also open a
brokerage account to make regular deposits.
The AIP automatically deducts a certain amount of money monthly from your
checking account. Dollar-cost
averaging requires little money to get started, and you are in control of how
much money you put into the investment regularly.
Dollar-cost
averaging doesn’t work during a rip-roaring bull market, or rising market.
However, when’s the last time you predicted a market rise?
Unfortunately,
few investments will be volatile enough for dollar-cost averaging to have a huge
advantage over a lump sum. For
example, the Standard & Poors 500 Index has reported monthly losses 1/3 of
the time in the past 35 years. Often,
the gains in the preceding month were enough to offset those losses.
On
the other hand, dollar-cost averaging works well for volatile sector
funds.Research has shown dollar-cost averaging to outperform a lump sum more
than 50% of the time.Funds in a single sector change more than broader investments.
Another advantage of investing a small amount like $50 a month in mutual funds
is that they do not charge commissions for monthly contributions.
If
you buy stocks from a broker with this strategy, you will have to pay a
commission each time you buy more shares. Those
costs will pile up if you are investing money monthly. Luckily, you can buy
stocks directly from a company without commissions when applying a DCA
strategy. Also, there are Web sites that offer as low as $2 a trade
online, which can help minimize the cost of using DCA.
Dollar-cost
averaging is another attractive option for investors who have little money to
put aside monthly.
Our example in the "Get Started" section shows that if you invest
$100 a month in the stock market soon after you graduate from college, you could
retire with over $2.7 million at 65, a sure way to become financially
independent like Tim and Tina in the story.
Indexing
is a strategy that involves buying exchange traded funds (ETFs) or mutual funds,
which mimic a market index. You don’t
buy and sell individual stocks; you trade the entire index.
Because this method requires barely any buying and selling of individual
stocks, indexing is thought of as a passive investment approach as opposed to an
active approach, meaning buying and selling carefully picked stocks to try to
beat the market.
Many
investors think of indexing as the virtual equivalent of investing in a market
itself, which can be very profitable for your portfolio.
For example, buying shares of Standard & Poors 500 (S&P 500)
index, with the stock symbol SPD, will give you ownership of the top 500 U.S.
companies. In addition, more often
than not, you will see a large market surge for the day, only to discover that
your stocks went down.Indexing mostly
guarantees that this won’t occur and if the market goes up, so will your
portfolio. Another benefit of
indexing is that you know your gains will equal those of the market.
This carries a large weight because the majority of mutual funds do not
do better than the market. Mutual
funds usually have part of their assets in cash and bonds, which reduce return.
Also, mutual funds have higher transaction fees and management expenses.
|
Index Name
|
Symbol
|
Index Tracked
|
|
Spiders
|
SPY
|
S&P 500
|
|
Diamonds
|
DIA
|
Dow 30 Industrial
|
|
Nasdaq-100
|
QQQ
|
Nasdaq-100
|
Since
indexing is a passive investment approach and needs few transactions, index fund
managers can charge less, meaning a higher return on your investment. The Vanguard 500 Index Fund, which mimics the S&P 500
index, is the largest mutual fund in terms of total assets (market value) and is
one of the best performing funds over the past 5 years. Another attractive feature of indexing is its tax advantage.
Investing in index funds has fewer capital gains distributions passed on
to the investor than do mutual funds. This
results in fewer taxes, meaning extra profits for you.
Many
index funds are available to you. The
most popular ones are the S&P 500 Index Funds since the S&P is
considered the benchmark of the U.S. market.
Other funds to choose from include the Dow Index Funds, Wilshire 5000
Index Funds, Russell 2000 Index Funds, International Index Funds, and Bond Index
Funds.
Since
index funds get many of their benefits from the long term, you should not expect
to make any huge profits from them as a short-term investment.Index funds represent major market indices and will move according to
them, whether up or down.
This method requires little effort and knowledge compared to stocks.
Indexing is an excellent, low-cost way for you to make profits for your
investment.
The Dogs
of the Dow is a simple investment strategy with an impressive track record over
the years. This method involves
investing the same amount of money in the 10 Dow stocks that have the highest dividend
yields and
holding those stocks for a year. At
the end of that year, you sell the Dow components that are not in the top 10 in
terms of highest dividend yields. You
replace those stocks with the ones that have joined the top-10 list.
Now, you may be wondering why this strategy uses highest dividend yields.
To calculate the dividend yield of a stock, divide the dividend per share
by the price per share. If the
share price decreases but the dividend remains the same, the dividend yield will
be higher. Therefore, Dow stocks
that have high dividend yields are the ones whose share prices have dropped and
are ready to recover.
An
important factor when using the Dogs of the Dow is to hold onto the stocks for a
full year. Stocks held for a year
or over are regarded as long-term investments, and long-term profits are taxed
at a lower percentage than short-term investments.Many investors using Dogs of the Dow buy and sell their 10 stocks
according to the calendar year, usually doing their trading in late December.
Web sites such as dogsofthedow.com will figure out the 10 Dow stocks for
you.
In the
past, the Dogs of the Dow method has worked extremely well, producing a
compounded annual return of 17.7% since 1973.
Over the same time period, the Dow had a return of only 11.9%.
From 1968 through 1998, $10,000 invested in the Dogs would have been
worth quadruple that same money invested in the Dow. The Dogs of the Dow continues to produce high returns.
In 1996, the Dogs of the Dow went up 28.6%, 22.2% in 1997, and 10.7% in
1998. All of these returns are much
higher than the 4% you might earn from a bank account.
From the
Dogs of the Dow, many variations have been created.
For example, with the Small Dogs of the Dow, you invest the same amount
of money in the 5 stocks that have the lowest share prices out of the 10 from
the Dogs of the Dow. These stocks
are thought to have more upside potential than the ones with higher share
prices. This strategy has actually
produced higher returns than the Dogs of the Dow, averaging about 20.9% since
1973. Another profitable variation
is the Foolish Four, invented by brothers Tom and David Gardner. This method takes volatility into account for your stock
selection. At the Gardeners’ site
www.fool.com, you can get the present Foolish
Four.
Before
you jump into purchasing the extremely popular Dogs of the Dow, you need to take
caution.The success of the Dogs of the
Dow and its variations depend on being able to buy stocks that are relatively
unpopular and benefiting from a turnaround.
As the popularity of the Dogs methods increases, the Dow stocks may
become more popular and the benefits of the strategy could begin to decline.
From: http://investsmart.coe.uga.edu/C001759