Buy and Hold
The “buy and hold” approach to investing in stocks rests upon the assumption that in the long term (over the course of, say, 10 or more years) stock prices will go up, but the average investor doesn’t know what will happen tomorrow. Historical data from the past 50 years supports this claim. The logic behind the idea is that in a capitalist society the economy will keep expanding, so profits will keep growing and both stock prices and stock dividends will increase as a result. There may be short term fluctuations, due to business cycles or rising inflation, but in the long term these will be smoothed out and the market as a whole will rise. Two additional benefits to the buy and hold strategy are that trading commissions can be reduced and taxes can be reduced or deferred by buying and selling less often and holding longer. Some proponents of the buy and hold strategy of investing often believe in the Efficient Market Hypothesis or the Random Walk Theory .
Market timing is essentially the opposite of buying and holding. Market timers believe that it is possible to predict when the market, or certain stocks, will rise and fall. It therefore makes sense to buy when the markets are low and to sell when they are high in order to maximize profits. Market timers can use any number of different methods for timing the market – technical analysis, fundamental analysis, or even intuition .
Most experts agree that market timing is incredibly difficult if not downright impossible. They also warn against it because:
- It’s hard to say when the market or a particular stock is “high” or “low”; often a seemingly high stock will go higher, and a seemingly low stock will go lower.
- Commissions eat away at your profits when you trade frequently, especially on small transactions.
- The bid/ask spread also eats away at your profits, especially for thinly traded stocks.
- In the long run, the market goes up. Unless you’re a superb timer, you’ll do better staying fully invested at all times. For example, in the last 40 years, the market returned about 11.3% annually. If you were fully invested the whole time, but got out completely for the 40 best months, your annual return would’ve dropped to 2.7%. If you miss the big moves it hurts, and no one really knows when they’re coming.
Growth investors focus on one aspect of a company: its potential for earnings growth. They believe that companies with high earnings growth will see their stock price continue to increase, since investors will want to own profitable companies that can pay large dividends in the future. The number that they pay the most attention to is earnings per share, especially how it changes from year to year, although they sometimes look at revenue growth as well . Some investors also compare the price/earnings ratio with the annual earnings growth, to get a feel for how much the market is willing to pay for a given rate of earnings growth. Growth stocks tend to be from young companies, so they are often riskier than the average security. They have the potential for large gains, but they also have the potential for large losses. In the 1990s technology stocks were the most commonly purchased stocks by growth investors, although growth stocks can exist in just about any industry.
Value investors look for stocks that are selling at an attractive price; in other words, they are bargain hunters. This does not mean that value investors buy stocks because they are “cheap” (such as penny stocks); value investing utilizes several measures of a company’s value to identify stocks that can be purchased for less money than they’re worth, regardless of whether they’re worth $10 or $100. Although it’s possible that a growth stock could represent a good value, growth investing and value investing are usually considered opposing strategies. This is because value investors tend to focus on traditional valuation metrics such as the P/E ratio, looking for low ratios which are typically not found in growth stocks . Value stocks often are ones which have fallen out of favor with the investment community for one reason or another, perhaps because they are in a slumping industry or because they reported poor earnings.
If you’re torn between the growth approach to investing in stocks and the value approach, then you might want to consider trying the GARP approach. GARP stands for “growth at a reasonable price” so, as you might expect, GARP investors look for companies with growth potential whose stock price is undervalued. That can be a difficult task since growth and value stocks tend to have opposing characteristics, but it’s not impossible. Most GARP investors look at the price-to-earnings-growth ratio (PEG) ratio in order to find bargain stocks with growth potential that are selling at a reasonable price .