The buy, hold, sell investment strategy review

In analyzing an investment strategy, a simple but useful thing that I like to do is apply my "three boxes" test to it. In itself, the 3 boxes test is quite simple, but it has some key concepts that quite a number of people that I have tried to explain this to find difficult to grasp. The 3 boxes are "buy", "hold", and "sell", and I tick the box if the strategy tries to make money in that particular action.

Not everyone accepts that there are 3 opportunities to make money in every investment.  You will often here the quote "It's only paper money until you've locked in your profits", and hence there is only one opportunity to make money - and that is when you sell and lock the profits in.

This line of thinking comes from 2 main sources.  Firstly, there is the accountants view, that says that until a "capital gains event" has triggered, you can't actually book your profits.  Similarly, the day-traders focus on market price, that zigs and zags so often that a particular zag is meaningless unless you sell, because it could zig in the next minute, wiping out you profits, and therefore, if you don't sell to lock in your profits, they could disappear in a puff of smoke.

I think that this view is very limited, and that it is for more useful to consider the 3 opportunities.  So, how do you make money in each of the buy/hold/sell opportunities?  Let's look at each individually.

To make money when you "buy" something,
you simply have to pay less that you think it's worth.  If you buy a dollar coin for 80c, you make 20c the instant that you bought it.  You don't need to sell it to someone else to "lock in your profits".

You may say that that would never happen, but it does all the time.  It's called bargain hunting.  Whether the bargain hunter is going to on-sell, consume, or treasure an item, they only buy it if they're going to pay less than they think it's work.  When I told this to property developer friend of mine, he instantly recognized it in the form of an old adage - "well they say that if you're going to make any money in a property development project, it's when you buy".

To make money when you "hold" something, you simply need to receive an income from owning the asset, whether that be dividends, interest payments, rent, or even retained earnings.  If your sell price is never reached, you may end up holding this asset for a very long time.  If your strategy hasn't ticked this box, it means that you will not be making any money during this period. 

Making money when you "sell" isn't as straight forward as you think.  If an investment strategy simply offloads the asset at market price - even if that's at a profit - then the strategy is not trying to make money during the sell.  Going back to the dollar coin that you bought for 80c, if you want to make money "during the sell", you would need to sell it for more than a dollar.  After all, you already had a dollar before the sell.  Selling it for "90c" to lock in your 10c profit is to ignore this box.

I observed another example of a strategy that aims to make money during the "sell".  I was at a cafe, and noticed that the paintings on the wall were for sale.  I liked them, and so I checked out the price, but they were way too expensive.  In fact, all cafe wall paintings seem to be overpriced.  Why is that?

It's because the cafe doesn't care if you don't buy.  They have a painting, and they are getting use out of it.  If they bought it at market price for $200, they stick on the wall for $400, and then they wait.  If ever someone buys it, they can then use that money at the market to buy 2 paintings and put them on the wall for $200 each.  So, the cafe initially had one painting, and now it has two paintings, and the instant that they "made money" was when the first painting sold for $400.

So, why is this important?

I believe that, for any investment strategy that does not tick all three boxes, there is a similar-but-better strategy that does tick all of the boxes.