Why buy and hold is (still) the best approach

This is the fifth of a six-part course on basic investing that we publish every Tuesday. An advanced lesson plan appears every Thursday.

Warren Buffett, the world's greatest investor, said it best: "Our favourite holding period is forever."

In a world of 24/7 financial news channels, countless investment blogs and endless corporate data on the Internet, the temptation for investors to react to this onslaught of information can be overwhelming. Should I buy? Sell? Add to my position? Go short? Use leverage?

Too often, the idea of doing nothing doesn't even enter into the equation. But if you listen to great investors such as Mr. Buffett, that's precisely what most people should be doing: nothing. Sure, Mr. Buffett buys and sells stocks, but plenty of his holdings - such as Coca-Cola and American Express - have been in Berkshire Hathaway's portfolio for decades.

The Oracle of Omaha summarized his buy-and-hold philosophy in his much-quoted 1996 letter to Berkshire Hathaway shareholders, which you can read here. It contains one of our favourite Buffett quotes:

"If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value."

Why is buy-and-hold the right approach for most investors? One reason is that most people are lousy market timers. They buy when markets are exuberant, and they sell when all hope seems lost. Anyone who dumped their stocks at the height of the recent financial crisis knows how well that worked out: They missed out on one of the biggest rallies in history.

Market timing may work once or twice if you get lucky. But consistently? Forget it.

"After nearly 50 years in the business, I do not know of anybody who has done it successfully and consistently," wrote John Bogle, founder of the Vanguard Group. "I do not even know anybody who knows anybody who has done it successfully and consistently."

Still think you can market time? Read this article and then ask yourself if you're smarter than the market.

There are at least two other reasons buy-and-hold beats frequent trading: Commissions and taxes.

If you're buying and selling constantly, the only person who will get rich is your broker. And if you're trading in a non-registered account, you'll have to pay capital gains tax every time you sell for a profit. Over time, commissions and taxes will cut into whatever return you hope to make.

Predictably, the buy-and-hold approach came in for harsh criticism following the market's collapse last year, with pundits declaring the strategy dead. Read Five Reasons Why Buy and Hold is Dead to see why.

And while it's true that the U.S. stock market is actually lower than it was 10 years ago - hardly an argument for buy and hold - over the long-term stocks have delivered superior returns to most other asset classes, particularly when dividends are reinvested in more shares.

That's not to say investors should never sell a stock. If a company's circumstances change for the worse and no improvement is expected, then there's little point in hanging on. Similarly, if an investment no longer fits your investment needs - say you're retiring and want to shift your money from stocks into guaranteed investment certificates - then it may be time to sell.

But for all but the most sophisticated investors, buying and holding high-quality stocks - or index funds that invest in the entire market - is the way to go. It's less stressful, reduces the risk of buying too high and selling too low, and keeps commissions and taxes to a minimum.

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