In the article last weekend, I discussed the concept of trying to catch falling knives and, quite predictably, I received some comments from readers justifying their own actions in buying falling stocks. One contributor set forth a very thoughtful plan through which he buys falling stocks with which he has had success, but was careful to note that the strategy is very risky. I agree completely and commend him for the construction and use of his plan that is set out in last week's blog. Another commentator defended his practice of buying GE as it was falling on the theory that it is a great company. I have a little more trouble with that one and liken it to a fellow who was upset with me a couple of years ago when I criticized elements of buy and hold because he and his family had been holding what he referred to as "that old doggie" Citigroup (C) since it was only $14. Citigroup is trading under $3 as I write this article.
First, I want to say that I have no problem with people trading GE. It is, indeed, a great company, and even in very significant downtrends such as GE has experienced in its fall from about $37.50 last year to its current level under $12, there have been several trading opportunities both to the upside and the downside. The key, in my view, is to have an exit strategy in place since we can always be wrong on direction. We also need to be mindful that GE, though a great company, has not been a great stock over the last 9 years. It traded near $60 in 2000 and if I had bought it then and held it until now, I don't think I would be very happy. It is not alone. Other great companies like Coca Cola (KO) have seen significant drops over that time as well. If a buy and hold advocate just bought the Dow near the high in 2000 he would be down approximately 3400 points as I write today.
The point I am trying to make is that a buy and hold approach with no exit strategy is extremely risky. To start, buying a stock is one of the riskiest things we can do in the market because, without stops or protective puts or some hedge, the risk is the whole investment. Great companies have failed and disappeared. There was a time when investors would have laughed at the suggestion that the great Pennsylvania Railroad could ever fail, but I watched as my own father, then a Federal District Court Judge, signed Order No. 1 in the Pennsylvania Railroad bankruptcy proceeding. Bankruptcy of General Motors was unthinkable not so long ago but we just saw it happen. The list of once great companies that failed is long, indeed. Those who were buyers and holders of those companies doubtlessly suffered. According to "Yahoo answers" American companies have been going into bankruptcy at a rate of 500 a week! Obviously most of those are not publicly traded, but publicly traded companies like GM definitely are to the great pain of shareholders.
I have little doubt that many will remain unconvinced, but buy and forget or buy and hold with no exit strategy is fraught with great danger. What if we bought at a top and have need for the money when there is a significant decline such as the one we have recently been witnessing or the one following the 2000 high? My suggestion to the buy and hold investor is to be aware that there is risk, sometimes enormous risk, and ask yourself the question: Hold until when? Why would you not want to have an exit strategy? If you exit and then the stock turns back up, you can always buy it again. Sure you may have to pay a capital gains tax (currently at a low rate) on the gain, but isn't it better to do that than to see your investment go down the tubes completely or suffer a large loss?
by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved
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