Buy-and-hold approach popular investment strategy
Timing strategies can bring more returns with less risk
Dual momentum strategy can protect against emotional decisions
Those who try their luck on the stock market strive to increase their investments there in the long term through returns. There are various investment strategies to achieve your goal. The so-called buy-and-hold strategy is certainly an option, particularly for small investors who may not have extensive knowledge of the stock market. This means that shares in a company are purchased and then held over a long investment horizon of ten to twenty years until a decent return is achieved. It’s a solid strategy that’s relatively reliable in generating profits.
However, even this buy-and-hold approach has its pitfalls. Because it only works well if you actually don’t touch your investment in the long term and can also sit out any weak phases on the market. However, if there is a high level of volatility, as is the case in the current market environment characterized by the corona crisis, other strategies can be far more efficient and immediately less risky.
Time of entry also important with a buy-and-hold approach
Because, as history shows, it is also important when exactly you enter the stock market as an investor. If you got in when the prices were very high and a crash followed unexpectedly, for example in the 1930s, it can take decades before a share has even reached its original value – not to mention any returns. Of course, there was a crash on the stock market as a result of the corona crisis, namely in March 2020, but many of the most important global indices have already returned to their old heights and even exceeded them. Accordingly, anyone who believes that the worst is behind us disregards the high degree of uncertainty that still prevails. Added to this are the sometimes dizzyingly high valuations on the stock markets, which in places suggest parallels to past bubble times.
Experts therefore assume that investors should be prepared for lower returns on the stock markets in the coming years. Anyone who still wants to continue making profits with shares could consider a strategy other than the established buy-and-hold approach. A timing strategy is recommended for investors with a little more stock market background knowledge, but it is not entirely uncontroversial, even among stock market players. Finding the right moment to enter or exit the stock market is an art in itself. Some investors rely entirely on their gut feeling, which of course involves a high level of risk.
Timing approaches as potential yield generators
However, there are also timing approaches with which one searches very strategically for the points in time at which one leaves the market or stays in it. Here, various momentum approaches have proven particularly useful for small investors who want to put together their own strategy. As the Neue Zrcher Zeitung explains, there are two strategies that are often combined into one – relative momentum and absolute momentum. While relative momentum is about finding a stock that has outperformed its peers over a 3-12 month period, absolute momentum is about finding stocks that have risen sharply over a 3-12 month period.
The NZZ showed how such a so-called dual momentum approach could look like in an example with the combination of two market-wide indices, each of which can be acquired by investors through an ETF. On the one hand, the Nasdaq 100 was selected as a technology-heavy US index, on the other hand there is the S&P Europe 350, which is more focused on long-established traditional European companies.
To find the right time to enter and exit the stock market, an investor could now consult the Nasdaq 100’s performance over a 10-month period to determine whether it has been positive or negative. If the index is positive, the investor buys shares, if the stock market barometer is negative, it’s time to get out or invest in cash. This decision is repeated at regular intervals, for example always at the end of the month. The Nasdaq 100 takes the decision to enter or exit from the stock market.
Now comes the decision, if one can buy, which of the two indices should be bought. Here the investor looks again at the performance of the two indices over the past 10 months. The one who is better off goes into the portfolio, the other one stays out. And so the Brsianer decides anew every month and always orientates itself on the two indices. So this is what such a dual momentum strategy could look like. The past shows that this approach can overshadow even the tried and tested buy-and-hold strategy in terms of returns. Because while you could have multiplied your investment ninefold with the dual momentum strategy over the past 20 years or so, a simple investment in the S&P 500 could only have increased a little less than fivefold over the same period – and with temporarily higher drawbacks.
let emotions out
Of course, this does not mean that this timing strategy is a sure thing, but the approach is interesting for investors, since the decision to enter or exit is not made on an emotional basis, but only before market conditions. Because even if it should be clear to most small investors that they should not be guided by their feelings when making investment decisions, the reality is often very different.
Two factors come together here: On the one hand, the so-called disposition effect ensures that when investors lose, they tend to wait too long before selling a share certificate in the hope that the losses will be made up for over time. On the other hand, profitable stocks are usually sold again too early. The background is the fact that most people tend to shy away from making losses. Red signs hit investors’ stomachs more clearly. Nevertheless, there is the additional effect that once losses have been made, further losses are perceived as less bad. So it feels less important to a Brsian if he loses 1,000 euros or 1,100 euros. However, he does mind if he loses 100 euros instead of losing nothing at all.
It is therefore important, although not easy, to let go of these feelings and look at your own expectations of a share certificate. What return should the stock bring in terms of fundamentals, analysts’ opinions, market conditions? Here, too, the motto applies that the portfolio should be checked at regular intervals. With a clear goal in mind, it’s easier to let losers go and hang on to winners.
Editorial office finanzen.net
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