The Death of Buy and Hold?

On Monday night, the Fast Money crew talked about the death of buy-and-hold investing. I agree that as a strategy, it’s in intensive care, but I’m not so sure it’s quite dead yet.

Whenever people start talking about the death of something, particularly with investing, is often the moment it’s about to surge. The classic example of this is Business Week’s “Death of Equities” cover from 1979.

The other reason for my skepticism is a misunderstanding of the arguments for buy-and-hold. I often hear people say, “Ha! The market’s down! Where’s your buy-and-hold NOW?” Well, the case for buy-and-hold isn’t that the market always goes up. Rather, it’s that buy-and-hold beats anyone else’s ability to time the market consistently, successfully and in a practical way. It’s that last part in italics that’s often overlooked.

If you can time the market successfully, fine. Go do it. In my opinion, I’ve never seen anyone who can do it consistently, successfully and in a practical way.

The other part of buy-and-hold obviously depends on what you buy and what you hold. Since I don’t believe in efficient markets, I don’t see buy-and-hold as synonymous with index investing. Many do. I think it’s certainly possible for investors to make reasonable decisions that will lead them to beat the market over the long haul. For example, if you had taken some basic steps like under weighting large-cap tech stocks at the height of the bubble, you’d be in far better shape today. Small-cap value stocks have had a pretty nice run over the last ten years (except for the last three months). This year, I avoided energy stocks and large-cap financial stocks, and it has served us well.

There’s also the issue of how long to hold a stock. I don’t see the importance of holding a stock forever, but I do see value in holding them for a considerable amount of time. Each year, I change five out of my 20 Buy List stocks. That translates to an average holding period of four years, which seems reasonable to me, though I can understand some buy-and-hold purists objecting.

Lastly, there’s also the issue of how long it takes a stock’s performance to reflect its true value. I think this may be one of the least-understood topics in investing. I’ll give you a brief summary. Let’s say that the stock market gains, on average, 0.05% a day with a daily standard deviation of 1%. (These numbers aren’t accurate. My point here is descriptive. I’m also aware of the problem of stocks returns and the normal distribution, but I’ll leave that aside for now). That means that 95% of a stock’s daily move is simply nonsense. It had zero bearing on the stock’s true worth.

After 25 days, more than a month of trading, the stock’s average return should be 1%. The standard deviation, however, is now 5% (note: this rises by the square root of the number of days). So even after one month of patience, the noise value has dropped to 83%.

At 625 days, or nearly two-and-a-half years, the average return and the standard deviation are both 25%. This means that even after holding a stock for 30 months, it’s perfectly reasonable to expect a loss or a minimal gain.

As I mentioned before, I used those numbers for descriptive purposed. The real figures would show that even more patience is required. Buy-and-hold could be dead, but the evidence isn’t close to being full. The bottom line is that the long-term advantage of holding stocks is real, but it takes a long time to show up.

Comments

[Steven Hansen:]

dow down 40%. to recover you need to gain 66%,

there is not one reputable analyst that predicts any major equities upward movement even several years from today. most recovery scenarios are for sluggish growth upon recovery. recession has not been built into the p/e ratios yet.

buy and hold is dead until the market settles down, and the economic future a little less uncertain. for now the big boys can play in the pond with the traders.

2008 Nov 12 04:36 AM

[investor88:]

Agree with comments by The hand. There will be a time for buy and hold but first we have to get through this rough patch. Todd Harrison [of marketwatch.com] says 1q2101 is market bottom, Fink of Blackrock says it is 1h2009. Watch and review but not a bad idea to let market show the way although the latter is easier said than done.

2008 Nov 12 07:47 AM

[robert.b.fe...:]

The whole idea of buy and hold is predicated on a long event horizon. Buying good companies at discounted prices right now will maximize returns ten or twelve years down stream. Timing the market precisely is nearly impossible but folowing trends for long term gains is predictable because we know that the market goes up and down.

2008 Nov 12 09:55 AM

[Mac77:]

Most folks concept of history starts at the beginning of their own lifetimes.

Buy and Hold was the dominate strategy from 1980 to 2000. It worked better than any other investment strategy over the last hundred years. However there were numerous other periods of history where Buy and Hold did not work at all....1920-1940...196... and beyond? It's not a question of the validity of Buy and Hold, it's a problem of your time frame is history.

There is an investment commercial where some guys are fishing on a boat at sea. They hear distant thunder and see some dark clouds on the horizon. They head back to shore and avoid the storm. Sounds like good investment advice (for these times) to me.

2008 Nov 12 10:33 AM

[John Lounsbury:]

If you bought the Dow Jones Industrial Average on 10/29/1998 (8495 close) you have a ten year return of no capital gain plus approximately 2% per year in dividends. Money markets have averaged more than this, even after taxes, and CD's have returned almost twice as much.

Buy and hold works in secular bull markets. Reallocate when the secular bear arrives. Mac77 has some good comments in this regard.

2008 Nov 12 11:44 AM

[John Lounsbury:]

I should not single out Mac77. All commenters have made good points.

2008 Nov 12 11:47 AM

[Smarty_Pants:]

"If you bought the Dow Jones Industrial Average on 10/29/1998 (8495 close) you have a ten year return of no capital gain plus approximately 2% per year in dividends" - jlounsbury59

Don't forget to include the effects of inflation during that interval to calculate real returns. From 1998 to today there was a total of 25.5% loss due to inflation per the BLS inflation calculator.

www.bls.gov/data/infla...

2008 Nov 12 03:55 PM

[Chris B:]

Basically what you're all saying is that because stocks went nowhere in the last 10 years, we should not use buy-and-hold for the next 10 years. That sounds like one of those find-the-fallacy problems on a standardized test. The answer is B: Past performance does not necessarily predict future results. In financial markets, it never has.

Those who change their strategy to what worked last time are making the same mistake as people who buy a stock because it has already gone up. it's an easy behavioral trap to fall into.

Market timing works best in hindsight, and many life savings have been lost by those who think they can predict the squiggles on the graphs. More successful investors can look at a company's financial statements and industry trends and predict their 5 year ROI. Then, due to unexpected events they are still wrong sometimes.

2008 Nov 13 09:43 AM

[bosun.j:]

Buy and sell is what the Banksters tell Joe Six-pack so he'll foolishly keep dumping his hard earned wages into a black hole called a 401(k).

2008 Nov 13 01:07 PM

[Pent up demand:]

"For example, if you had taken some basic steps like under weighting large-cap tech stocks at the height of the bubble, you’d be in far better shape today."

Yes, because it was obvious to everyone when the bubble reached its height. So you begin your defense of buy and hold by recommending a little fortuitous market timing?

If you expand your time and geographical horizons, buy and hold doesn't look so good. How many countries fell to socialist revolutions in the first part of the century? How many were devastated by wars? Those investors are not factored into the buy and hold track record because they did not survive (literally in many cases).

2008 Nov 13 02:25 PM

[Chris B:]

I think a buy-and-hold strategy has room for selling if you realize that the value of a company you own is far less than the current price, as in the tech bubble, or if you have done your research and identified a more attractive way to purchase future earnings. In no way does a BaH mentality prevent you from selling a stock that you feel has no future (Smith-Corona typewriters or General Motors, 1985) or that investors have bid up to absurd valuations (Yahoo! or Amazon.com, 1999). It doesn't mean sticking with a purchase no matter what.

It's more like the opposite of day trading and market timing strategies. Studies show it beats them.

2008 Nov 13 04:00 PM