A lot of investors are fond of ideas like “buy and hold”. It sounds like easy money! Just plunk your life savings down, diversify, and voila in 20 years you’ll be rich!
Buy and hold might work for assets such as growth stocks, but it is not a good idea in other markets. Savvy long term investors should avoid markets such as IPO’s, long term government bonds, junk bonds, and real estate in unfamiliar territory. Here’s why.
New IPO’s tend to get a lot of investors talking. For example, most of my friends in 2014 were asking questions like “do you want to invest in Alibaba’s IPO?” My answer is always no. IPO stocks are not good long term investments.
Companies that are about to go public spin big stories to convince skeptical investors. It’s easy to buy into the narrative about why the company is “changing the world” and “disrupting the industry”. Those are all just buzzwords that few companies actually live up to. Then a few years later the stock craters because investors come to the awful realization that the company will never be profitable or that it’s grossly overvalued. For example Groupon, Demand Media, and Twitter all went public at very high valuations and could not justify those valuations with profits.
Some of these companies that go public are good long term investments e.g. Google in 2004. But a lot of these IPO’s are just “exits” that allow the founders and initial investors to dump the overvalued stock on the unsuspecting public. A lot of these tech stocks have no hope of being profitable ever. It is almost impossible to differentiate the IPO’s that turn into good long term investments and the IPO’s that fail.
The point is, investing in IPO’s are definitely a lot riskier, and as an average investor, you don’t have many of the advantages that the pros do. Hedge funds are often allocated shares by the banks that are leading the IPO’s. When the stocks soar on the open, these hedge funds book massive profits and average investors are forced to buy at much higher prices.
Long term government bonds
Long term government bonds like 30 year Treasuries have interest rates that are higher than short term government bonds. However, these bonds are terrible long term investments. Long term bonds have multiple risks associated with them. Interest rates can and will fluctuate a lot. 30 years is a long, long time. Over the past 30 years, U.S. interest rates have fluctuated from almost 10% to 1%! If you buy a long term bond right now at 2% and in a few years it goes to 8%, you’ll want to kick yourself mentally.
In addition, perhaps the government will default on its debt! The risk of a default is low right now, but a lot can happen in 30 years. The U.S. already has a staggering amount of debt, and it seems that this debt will only increase as the years go on.Interest rates are at all time lows right now. Hence, interest rates can only go up. Why invest in a bond that yields 2% when you can invest in a 5% bond in just a few years?
With very low interest rates around the world right now, a lot of investors are looking for relatively high-yield assets. Junk bonds fit this picture. Junk bonds are high yield and high risk bonds.
These bonds are primarily issued by companies that have trouble raising capital or companies that were just taken over. Any company that has trouble raising capital should worry investors. The long term prospects of a junk bond company are not very solid, and perhaps the company will be unable to service those bonds in the future (i.e. go bankrupt).
Real estate in an area you’re not familiar with
Unlike stocks, real estate is not a standard investment. Real estate is very location specific. Real estate gains can vary widely even within the same city, depending on the neighborhood! It’s easy to get caught up in hype like “real estate is rising rapidly in California, so I should invest there!” Unless you’re very familiar with the area and understand that local market well, don’t invest in it.