Buy-and-hold stock strategy can be big loser in bear market
-- Buy shares of good companies and hang on. That's the way millions of investors have been trained to almost religiously invest for the long haul. Even Warren Buffett likes to say his favorite holding period is forever. But this seemingly common-sense approach, which has worked remarkably well over the decades for patient investors, proved extremely treacherous during the bear market. Investors holding onto some well-known stocks saying "they will come back" often found themselves holding onto stocks with next to no value.
Since the start of the decade, shares of 25 U.S. companies that had market values of $4 billion or more are now trading for $2 or less, according to a USA TODAY analysis of data from Standard & Poor's Capital IQ. Half of those were even booted from a major stock exchange and now trade on lightly regulated markets.
General Motors was the most recent example. Shares of the hallmark of American enterprise traded for nearly $73 a share on the New York Stock Exchange in 2000. Now, GM trades for less than $2 on the Pink Sheets market.
That's what makes this twist so shocking. Household-name companies, several with massive market values, seemed to be exactly the kinds of stocks to safely hold long-term. But many of these well-known stocks ended up crashing like fly-by-night penny stocks. The list of other stocks investors rode down to practically nothing includes financial firms American International Group, Fannie Mae, Freddie Mac, Washington Mutual and E-Trade, technology stocks including Level 3 Communications and Conexant Systems, and retailer Circuit City.
The market's vicious kicking the life out of stocks has been a brutal wake-up call for investors who long held out faith that holding on is the only way to go.
A painful lesson to learn
John Canelake, 88, long taught his children that patient, long-term investing was the way to go. As the founder of candy store Canelake's Candies in Virginia, Minn., Canelake has watched the value of his stocks rise and fall but found sticking with them through the ups and downs almost always paid off.
Not this time. Canelake invested in Great Western in 1980 and saw his holdings hit $80,000 after the bank was bought by Washington Mutual. Now it's worth just $200. "I was in the habit of (buying and holding stocks)," Canelake says. "I don't think it's so good now."
In many ways, riding a stock down as it plummets is part of human nature, says Robert Shiller, finance professor at Yale. Humans dread facing regret over a bad decision. People will go to great lengths to avoid or postpone the feeling that they made a mistake, he says. "People are highly motivated by avoiding the pain of regret," he says.
"The problem with selling stocks when they're going down is you're forced to confront the fact you were wrong," he says. "You can avoid the pain of regret, or postpone it, hoping a stock will come back."
The implosion of banks such as Washington Mutual was especially hard for many individual investors to take. Not only have bank stocks been traditionally relatively stable, but some investors had the added comfort of being the banks' customers.
Wilma and Dennis Patzkowksi, 68 and 70, knew stock investing was gambling. But they felt good about holding Washington Mutual — also owning it through an original investment in Great Western. They'd been Golden West and Washington Mutual customers for 35 years. They'd even visited employees at their local Washington Mutual branch when the stock was falling to see if there was a problem. They walked away reassured. "You buy what you know," Wilma says. "You figure they'll go back up."
But Washington Mutual crumbled from $17.25 a share in early 2000 to 10 cents now, shredding $21,000 of the Patzkowski's nest egg. Wilma says she'll never have such faith in a stock and, in fact, is all but swearing off the stock market. "I don't trust any stock anymore," she says.
Mutual funds are less risky
Investment professionals worry investors will confuse the prudent strategy of buying and holding a diversified mutual fund, which owns many stocks, with the dangerous practice of buying and holding individual stocks. Individual stocks are much riskier than diversified baskets of stocks because they are subject to company-specific risk, says Mark Hebner of Index Funds Advisors.
The risk of believing too much in an individual stock was a lesson learned by Ken MacGarrigle, a government worker based in the Washington, D.C., area who lost nearly all his investment in Lucent. Lucent was one of the most widely held stocks in the early 2000s, and was considered a symbol of American ingenuity. "I figured, hey, I don't even have to monitor this," says MacGarrigle, who declined to give his age or size of his loss in the stock.
Lucent, though, crashed more than 98% and no longer trades in the U.S., so it doesn't count in the list of 25 stocks in the USA TODAY analysis. Now the stock is Alcatel-Lucent trading for 1.81 euros, down from nearly 90 euros on an adjusted basis in 2000, Capital IQ says.
MacGarrigle still hasn't sold the stock, but rather just looks at it languishing on his brokerage statement waiting to take the tax loss. "It was always, you buy these big stocks and they will always make you money," he says. "That's not true anymore."
That leaves many investors looking at brutal losses and unsure how to get back to even.
Richard Ley, a 52-year-old social worker in Columbia, Tenn., lost nearly $30,000 on his investment in General Motors. He bought the stock thinking it was "a stock that paid a dividend and will be around," he says.
What's Ley's plan to get back to even? Buy and hold. This time, though, he's planning on holding onto shares of software maker Microsoft, figuring that company has staying power.
But the GM experience has renewed his memory of the risk of investing. "Yes, GM was an unusual case," he says. "But this market is an unusual case, too."