Buy-and-Hold vs. Timing

by David Van Knapp, author of

SENSIBLE STOCK INVESTING:

How to Pick, Value, and Manage Stocks

THE TOP 40 DIVIDEND STOCKS FOR 2010:

How to generate Wealth or Income from Dividend Stocks

November, 2006

The most important factor in stock market success is controlling risk.

Risk, of course, includes not only the possibility that you will lose money, but

also the possibility that you will miss out on a chance to make money.

The Sensible Stock Investor uses a variety of methods for managing risk. One

of these is timing. Timing means selecting the optimum point in time to

make a transactionto buy or to sell.

Much stock investment literature derides timing as a risk-control measure. Most

advisers focus solely on asset allocation, diversification, and perhaps hedging

strategies. For example, whenever you see statistics about how much of your

money you should have in large-cap stocks, small-cap stocks, bonds, cash,

etc. the recommendations are based on long-term performance statistics for

those asset types. In other words, the advice is always based on the

presumption that you will Buy and Hold each asset. That underlying premise is

almost always unstated. The use of timing as an additional way to control risk is

ignored or criticized as impossible.

However, to the Sensible Stock Investor, timingthat is, not Buying and

Holding everythingis a valid risk-control technique. It turns out statistically

that not being invested in stocks when they are going down contributes

much more to positive returns than being fully invested all of the time.

Timing can be used in both buy and sell decisions. It helps determine when to

purchase a stock (thus reducing the risk that you will miss out on a chance to

make money on the stock), and it also helps determine when to sell it (thus

reducing the risk that you will lose money on the stock). Even Warren

Buffettwho is reflexively associated with Buy-and-Holdpractices

timing. There are many periods when he holds a great deal of his assets in

cashwaiting for the right time to buy. And he has sold more than a few stocks

in his career—he does not hold onto everything forever.

Therefore, timing is a tool in the toolkit of the Sensible Stock Investor to

practice risk management. It does not fully control buy, hold, and sell

decisions, but it does influence them. The idea is to have more of your money

in the market when there is a greater chance for gain, and to have less invested

when there is a greater chance for loss. The whole idea is to stack the odds in

your favor as much as you can. Timing helps you do that.

Timing is based on indicators. Indicators are simply pieces of information that

may be predictive of future performance. Thus, they are signals whether to buy,

hold, or sell. Wed like to be more fully invested when the market is going up,

and less fully investedor entirely in cashwhen the market is going down.

Indicators can help us toward that goal.

Because individual investors cannot spend all day studying the market, the best

data for developing a timing indicator for the individual must be (1) readily

available, (2) free, and (3) easily understood. It turns out that we can find such

information without too much trouble.

For example, I employ data on broad market trends, broad market valuation,

economic trends, and interest rates. I put them together into a straightforward

timing indicator that I call the Timing Outlook .

The idea is that the Sensible Stock Investor can use the Timing Outlook to

influencebut not totally determinehis or her decisions about when and

whether to buy, hold, or sell particular stocks or ETFs. The Timing Outlook is

used in conjunction with the other tools of Sensible Stock Investing. The whole

toolkitselecting excellent companies, valuing their stocks, maintaining a well-

rounded portfolio, controlling risk, and so oncreates a sound latticework of

complementary techniques. These techniques lead to superior results, principally

because they help you to manage investment risk.

A word about psychology: The Sensible Stock Investor creates all his or her

tools as objectively as possiblewhen he or she is thinking most clearly, not in

the heat of a fast-moving market. Psychologically, it can be hard to follow any

system which is giving a seemingly non-intuitive signal. But thats why you have

a system in the first place: So you can follow it when objective thinking is most