You may have heard from investment gurus and financial planners that investors need to be disciplined and should invest from a long-term perspective. In short, they suggest a ‘buy and hold’ strategy. And though disciplined investing is something that we too are in favour of, we have our doubts about the buy and hold strategy. Having said that, a genuine question pops up which is that when the future is unknown and uncertain, how one can state for sure whether to buy, hold or sell a particular stock, index or mutual fund?
Of course, we can just come out with a probable situation but cannot predict it. This is the question that led us to analyse and understand whether or not at all the ‘buy right and sit tight’ is a prudent investment strategy, in particular for mutual funds considering that they are promoted more as long-term investments than stocks. It is equally important then to know if there exists a viable alternative.
Buy Right and Sit Tight
To begin with, let us understand what is the buy right and sit tight strategy is all about. As the phrase itself suggests, it is a strategy wherein you identify a stock or a mutual fund, invest in it and then forget it. According to this strategy, a quality stock or a mutual fund would always provide you with better returns in the long term. Consider the illustration alongside to understand this better. As an example, let us assume that you invest Rs 1 lakh in S & P BSE Sensex in November 2000 and forget about it till October 2020.
The above graph shows how your investment would have grown if you had adopted a buy and hold strategy in S & P BSE Sensex for 20 years. Your investment of Rs 1 lakh would have become Rs 10.46 lakhs in 20 years i.e. it would have grown by more than 10 times. And the compounded annual growth rate (CAGR) would be 11.79 per cent. All you did was to have bought it and then held it till the end of its tenure.
The above graph shows the three-year rolling returns for the same period as has been considered for our case study. Here we can clearly see that the three-year returns have fallen quite a bit lately and have also turned negative. Although the average three-year rolling return is 15.53 per cent, the variation in returns is huge. There was a period when the returns were greater than 50 per cent, while during other instances they were negative 10 per cent. Nonetheless, deeper analysis shows that it is more due to a polarised performance of the Sensex constituents where a few stocks did exceptionally well while a majority of them performed poorly. For these reasons, the buy and hold strategy may not always work.
Debunking the Strategy
There are four things that make the buy right and sit tight strategy futile.
We all know the importance of diversification. You may have heard the maxim of never putting your eggs in one basket. Hence, asset allocation has its own advantages. So, let us move on to the basics and understand why we need to diversify and have a proper asset allocation in place. One particular asset class is never a consistent winner. Though equity as an asset class performs better in the long run, that does not deem it a winner all the time.
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