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Active money management or buy and hold?

The case for buy and hold

Buy and hold is the mantra of famous investor Warren Buffett. This investment strategy can involve individual stocks or passively managed funds.

"Buy and hold became a successful strategy because it moved people away from trying to time the market," says Chris Farrell, economics editor for American Public Media's weekly "Marketplace Money" radio show. "Timing the market is hazardous to your wealth. None of us has a crystal ball that can tell what's going to happen in the market in six months."

In a buy-and-hold portfolio, stocks or funds are bought and held for a long period of time. While there may be short-term fluctuations (business cycles, inflation, etc.) over that period, over the long term all of those economic ups and downs level out as the market as a whole rises. Most importantly, trading costs, fees and commissions are considerably lower with this investment approach, and taxes can be reduced or deferred by buying and selling less often.

"It's not simply 'buy and hold,' but 'buy and hold, rebalance and tax-manage,'" says Larry Swedroe, principal and director of research for The Buckingham Family of Financial Services, and author of seven investment books, including "The Only Guide to Alternative Investments You'll Ever Need."

"It's never been buy-and-hold-and-forget," he says. "You need to adapt to changes, you need to annually review your investment plan to make sure that its underlying assumptions haven't changed significantly over the past year, and you make changes that are reflective of those as they happen."

Stocks will always have a risk component, says Swedroe. However, it is that same risk premium that has also made them such a historically successful and rewarding long-term investment.

Both Farrell and Swedroe favor using low-cost, low-turnover index funds over actively managed funds.

"Properly buying and holding a well-diversified portfolio of passively managed stock index funds, both domestic and international, is one cost-effective way to participate in the growth of the global economy," says Farrell.

Standard & Poor's keeps a scorecard of how its indexes perform relative to active funds, and there are no clear victors since the results can be interpreted favorably by proponents of both investment approaches.

Over the five years ending in December 2009, the majority of index funds outperformed active funds in all but two of 17 domestic fund categories. The two exceptions: large-cap value funds and real estate funds.

However, when assessing asset-weighted returns (meaning a fund's returns are weighted by its total assets), S&P found active managers level or ahead of indexes in all but two categories: mid-caps and emerging markets.

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