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Investing strategy: Buy and hope?

By Sheyna Steiner ·
Friday, September 3, 2010
Posted: 9 am ET

Buy and hold is the passive investing strategy that some investment advisors love to hate -- of course, if they're getting paid for trading in your account then they definitely hate it. Nonetheless, all the antipathy towards passive investing can't be ascribed to cynical motivations hidden deep in the hearts of the active money management crowd.

Buy and hold is difficult for investors to practice. A Boston-based financial services research firm, Dalbar, studies investor behavior and has found that investors behave irrationally when the market drops.

In their 2010 report, Quantitative Analysis of Investor Behavior released in March, Dalbar reported that an investor who bought an index fund in 1990 and held it through 2009 would have earned about 8 percent per year. The firm calculates that by the end of 2009, a 20-year equity fund investor actually earned about 3.17 percent per year.

That's a huge discrepancy.

Investors trade their funds too often to benefit from a buy and hold approach, often bailing out of their investments at precisely the wrong time as well. For instance, after the flash crash in May this year, investors fled equity funds with about $19 million leaving domestic funds that month alone, according to ICI, a trade group for the mutual fund industry.

There are arguments in favor of both active money management as well as passive investing but, no matter which you choose, sticking with your plan is the key to making it work.

But surely people know that by now.

There are many theories on why investors act against their own best interests and the general consensus is that it's all in our heads. Investor psychology or behavioral finance is a booming field. A 2006 Bankrate story broke down some of the more common psychological quirks that cost investors money.

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