Reexamining the 2nd Key Rule of Successful Investing: Buy and Hold

You may recall that missing the market’s top-performing days by trying to react to “news” or speculation can prove costly to a portfolio. Remember the hypothetical investor who missed only the 10 top-performing days during the 20-year period from 1993–2012? By selling his investments and being out of the market for 10 days out of 20 years, that investor would have earned half as much as an investor who remained in the market for the entire period. By missing 10 days, he would have left 50% of his potential gains on the table. Constantly buying and selling not only has its own costs (commissions on transaction costs) but also risks missing out when an investment begins to move up again.

In addition to transaction costs, frequent trading results in higher taxes. That’s because Short-Term Capital Gains (profits from assets held for one year or less) are taxed at the same rate as income (10–39.6% in 2015), which is higher than the tax on Long-Term Capital Gains (profits from assets held for longer than one year) which are taxed at a lower rate (generally 15% or 20%) than income.

Now, you may be adhering to the principle of Buy and Hold, but the same might not be true for your fund manager. To assess how much buying and selling has been going on within a mutual fund, you must review the turnover percentage. A fund turnover of 50% means that 50% of the stocks in your portfolio have changed since last year. Every time your fund manager buys and sells a stock, there is a cost. It’s called the “Bid/Ask Spread.” These costs are passed on to you and hurt your returns.

This also means that your fund manager is gambling with your portfolio, buying and selling stocks he thinks are winners and losers.