Active Versus Buy And Hold Investing

by Alan Lavine and Gail Liberman

The market declines over the last 2 3/4 years seem to have made a stronger case for active investing over passive investing.

After all, by taking an active approach to your investments, you could have pulled out of the market before everyone else got clobbered.

Active investors follow investment trends. Passive investors invest regularly among stocks, bonds and cash. However, despite the seemingly attractive climate lately for active investors, passive investors hold their ground.

Here are the updated thoughts of two strategists on these opposite philosophies.

"The market tells you how to invest," believes William E. Donoghue, a Seattle-based money manager. "Proactive investment means investing in a diversified portfolio of investments that are going up and getting ride of those that can't keep pace. I am wrong 55 percent of the time. But 45 percent of the time I have earned more than I have lost."

Donoghue uses relative strength indicators that show if a mutual funds price is trending up or down.  One of his systems invests in sector funds, which invest in specific industries. His other system invests in long/short funds that do well in down markets. 

Donoghue says he is doing well in this bear market. Over the past 2 1/2 years ending in June, his sector fund rotation system is up a total of 15 percent. Meanwhile his long/short strategy is up 25 percent, less fees. By contrast, the S&P 500 was down a total of -33 percent. To view Donoghue's system go to www.thedonoghueplan.com.

James M. Barry, president of Barry Financial Services, Boca Raton Fla., contends that such market timing does not work over the long- term. The reasons:

* Stock gains tend to come in brief spurts. Stocks gained 26 percent in 1991. Two-thirds of the return came in just a 21 trading days. It is difficult for a system to pick up those kind of trends.

* The stock market moves randomly upward over the years. You can get whipsawed with market timing. That means you invest only to find prices moving down. Or, you sell and prices move higher. 

* If you missed the 10 best days in the stock market over the past decade, you underperformed the S&P 500. 

Barry recommends staying diversified in stocks, bonds and cash based on your goals and cash flow needs. You can view Barry's philosophy at talkmoney.com.

"If you look at the monthly returns in the market since 1976, it looks random," Barry says. "So are you going to sell after an investment is down a couple of months? You will end up getting back in at a higher price."

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.