The Right Way to Buy and Hold

Performance Says It All

If you don't believe the research, then go to the numbers.

The vast majority of top-performing stock funds over the last 15 years are run by managers who don't trade a lot. That list includes names such as (SEQUX Quote)Sequoia, (DODGX Quote)Dodge & Cox, (LLPFX Quote)Longleaf and (CFIMX Quote)Clipper. These stock pickers invest in solid companies selling at good prices, and they hang on.

Trading Will Cost Ya

In fact, investors who don't trade a lot also have an enormous performance advantage: They aren't blowing their gains on trading costs.

If you trade aggressively, then commissions and other transaction costs can eat up any profits you might make. And you'll pay taxes on any gains you realize. In fact, the tax code is stacked against people who don't hold on to their stocks for a year. Short-term gains are taxed like ordinary income. And long-term gains are taxed at just 20%.

Another problem with trading: Those price targets some investors come up with have no basis in reality. They're completely arbitrary. Just because AOL Time Warner's(AOL Quote) stock once traded at $55 a share doesn't mean it will ever get back to that price. The same thinking applies on the downside as well. A number, by itself, doesn't mean a thing.

Not Enough Hours in the Day

Professional investors will tell you how tough it is to trade stocks. And they do it for a living. If you've got a job that doesn't involve sitting in front of a Bloomberg machine, then you aren't going to have enough time to trade during the day.

And after work, wouldn't you rather spend your free time with your spouse and family instead of doing research or staring at charts?

But the preceding screed isn't meant to suggest that you should build a portfolio of stocks or funds and then ignore it for 10 years -- or even 10 months.

You need to rebalance how much money you have in different stocks, sectors or asset classes at least once a year -- if not once a quarter. The exercise prevents the risk profile of your portfolio from changing dramatically.

This tactic also helps you sell high and buy low. You're systematically skimming the profits off the top of your portfolio and moving money out of areas that are probably more expensive.

Say you started 2002 with half a $10,000 in the (VTSMX Quote)Vanguard Total Stock Market fund and the other half in its (VBMFX Quote)Total Bond Market fund. By the end of the year, that portfolio would have had 42% in stocks and 58% in bonds. By rebalancing back to that 50/50 mix, you're keeping the portfolio from becoming a little too conservative. And you're taking some profits in bonds and putting some money into stocks, which look reasonably priced when compared with bonds right now.

Plus, this methodical strategy actually works. For most people, trading does not.