Option Investor

Covered-Calls 101

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Should You "Buy And Hold" Stocks?

With the recent rise in share values, it's no surprise that the benefits of the "buy and hold" concept are again being touted in a variety of investing forums. Indeed, while a few so-called trading gurus continue to hype the rewards of the latest short term, high profit strategy, most financial experts remain steadfast about the advantages of long-term equity positions. Regardless of how you approach stock ownership, there is merit to this type of investing - especially in those cases where writing covered-calls can enhance its profit potential while limiting capital risk. In addition, it is still the most (statistically) successful investing strategy in the financial markets.

Many investors believe that owning a variety of stocks in different categories and classes will provide the best ratio between risk and reward in a conservative portfolio. Certainly, a diverse group of quality, long-term equity holdings offers a good foundation for almost any type of investor and putting these issues in a retirement account can help defer capital-gains taxes. Those who plan to utilize the buy and hold approach should focus on purchasing proven companies with current market prices that are at a discount relative to their fundamental economic value. By accumulating these issues at a favorable cost basis and sizing each position appropriately, an investor can enhance the potential for capital gains from increasing share values and reduce the possibility of unacceptable draw-downs.

Considering the historic relationship between corporate earnings growth and share price appreciation, there is certainly wisdom in the buy and hold methodology. However stocks can also be used to generate income and investors who want to receive cash proceeds from their portfolio on a regular basis can choose from a vast number of dividend paying securities, many of which also have an excellent record of share price growth. In addition, those individuals who choose to avoid specific types of business activity (based on ethical or financial principles) will find an assortment of value-based stocks that meet their personal criteria. Finally, more aggressive players can benefit from the unique advantages of options by selling at-and out-of-the-money calls on suitable portfolio issues.

Strategy is important however it is also imperative to approach investment activities with the right attitude and expectations. Trying to achieve excessive gains with a portfolio of stocks can put your brokerage account in the red quickly (because greed can lead to terrible decisions) while accepting returns that barely surpass current inflation rates will prevent you from achieving your objectives. Although buy and hold has worked well throughout the last quarter of the century, the slump in corporate share values during the early part of this decade clearly demonstrates the need to be proactive with your core holdings. As you would expect, the majority of investors who make the effort to learn about the financial markets are not satisfied to achieve the same return as the Dow Industrial Average or the S&P 500 index yet a large percentage of market participants seem to actively seek mediocrity. In fact, history suggests that much of the general public is comfortable losing what the market loses and gaining no more than the market gains. Fortunately, modern information technology and ease of access to financial forums ensures there are always numerous opportunities that the average investor can profit from with various stock and option trading strategies. As with any complicated endeavor, the key to success is to follow a carefully planned approach with precision and discipline.

Some of you may be wondering what rate of return might reasonably be expected from a conservative, equity-based portfolio. Most professionals who participate in historically profitable stock-ownership strategies easily average 15%-20% return on an annual basis. Over the long-term, 10%-12% per year is often listed as the median gain for broader-market stock indexes and amazingly, Warren Buffett accumulated his fortune (Berkshire Hathaway is billions of dollars) by focusing on a mere 15% annual return on assets. His primary goal however, was to maintain a substantial margin of safety in all of the portfolio's holdings. In view of the potential for a sizable pullback in the current market, that approach is even more valid and it's definitely something to keep in mind when you start shopping for the new additions to your long-term portfolio.

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