Buy And Hold: Beware the Devil You Don't Know

I fully intended to write an article bashing the buy and hold strategy, and indeed part of me still wants to write such an article, as there is much to bash. I even had a title prepared: Buy and Hold Didn't Die, It Never Really Lived. (Cue the YouTube video of Braveheart)

But alas, it is difficult to confirm the death of buy and hold investing when so few of its defenders actually mean the same thing when they defend it. There are several buy and holds. Here are some samples:

• An article found on InvestorPlace suggests that underweighting certain sectors and changing 25% of the stocks in one's portfolio each year is a version of buy and hold investing. (Is that really holding?)
• An article from Motley Fool says the goal is to find a stock that you "never, ever" need to sell. (How does one make money with that strategy?)
• An article found on Seeking Alpha talks about understanding secular and cyclical bull and bear markets. (Why? To better time the market?)
• Finally, an article from Forbes online drops the names of heavy hitters like Grantham, Siegel, Malkiel, Bogle, and--cue music--Buffett to support sticking with buy and hold. (But don't all those guys have different strategies?)

I'm not sure which buy and hold strategy to bash. But as I was doing some research, I realized it's not so much a specific strategy that bothers me, it's the conventional wisdom that bothers me. Conventional wisdom is dangerous because it is what the masses take for granted, it is the lowest common denominator of understanding. In the form of conventional wisdom, the buy and hold strategy has become a soothing crutch for the average investor, a call to inaction, a warning against straying from the path of pseudo-scientific statistical outcomes:

Don't try to time the market, it can't be done. It's better to do nothing! Just buy and hold. Everything will be fine in the long run. Assume 8% annual returns and plug it into the retirement calculator. Above all, never panic. Do not to interrupt the wealth machine with your simple emotions.

When I think of buy and hold as conventional wisdom, I think of my mother. Like most people, what she knows about investing comes from pamphlets received from kind and well-meaning financial planners. If I were to ask her what buy and hold means, she would probably say that it means you are supposed to keep putting money into stocks (or, more likely, mutual funds) and hold onto them because over the long term, the stock market always goes up...eventually.

You may say this is a caricature of buy and hold, but this is how conventional wisdom works. When the market goes down, casual investors consider it outside the norm and become confused, nervous, or even angry and helpless (What should I do? I can't sell, can I?). A few might become overconfident and throw good money after bad. They trust the strategy and its familiar simplicity, and they are not often presented with alternatives. Worst of all, they are not taught risk management. Why have a stop-loss when the market always comes back?

When buy and holders speak of risk, they are usually not referring to risk at all. They speak of missed opportunities. They trot out charts and studies that show (as always, over the long term) the dangers of not being in stocks, with relative performance (how one does compared with the S&P 500) as the measure of success. However, in this day and age when savings and retirement funds are invested in the markets, when the lines between saving and investing have been blurred, shouldn't people be aware that there have been long periods of time where markets go down or sideways? Shouldn't people be shown a chart of Japan's Nikkei 225 from November 1989 to today?

That should make you think. It's Japan, not Zimbabwe. Now of course it is absurd to say that the past returns of the Nikkei over a certain period of time are indicative of future results (disregarding the similar storyline of a real estate bubble, extremely low interest rates, and a deflationary environment). But it is just as absurd to use buying Microsoft in the 80s as an example of a buy and hold strategy.

The truth is that past returns are not indicative of future results, it's more than a disclaimer, and no amount of academic studies referencing the market's history can change that. We can use history as a guide, but that's not risk management. Risk management isn't planning for the norm, it's protecting yourself against the extreme or unusual (read some Nassim Taleb, please).

 

You may now be thinking that I've decided to just bash buy and hold after all. Not so. (Okay, I did get some shots in.) I respect that some investors, using their own version of a buy and hold strategy, have been quite successful. But some have been unsuccessful, perhaps by picking the wrong stocks and holding them to near zero (yes, smart people have done this). In the same way, there are successful and unsuccessful short term traders who attempt to time the market and use a variety of methods.

My point is not that one method of investing is better than any other. I have my preference, which fits my personality, risk tolerance, time horizon, and skill set. My point is that buy and hold has become conventional wisdom as the "right" approach for the casual investor, whereas day trading has become synonymous with risky behavior. The truth is that while both approaches have risks, only one of the approaches readily acknowledges that risk. So which is more dangerous--the devil you know, or the devil you are led to believe does not exist?

Comments

[investor88:]

Agree buy and hold is not the holy grail of investment. However for the average person it is a good system to follow because of its simplicity provided it is followed systematically, over the very long term.

2008 Nov 17 08:02 AM

[doylegroup:]

There are some stocks that buy & hold work. I bought XON (exxon) 12 yrs ago for $68/share. A lot has happen since ..merge w/Mobil XOM..continue to raise dividends.. 2 stock splits. The results ..current effective yield 9%.. 17$ basis...current $74/share. The company has done everything an in vester could want. I still will continue to hold the stock. Does any one think US wil quit useing oil?

2008 Nov 17 10:08 AM

[bobbobwhite:]

It would be truly tragic to find the present catastrophic market at the end of a 30+ year, retirement account buy and hold period. Many stocks today are at 15 and even 20 year lows, and some are even at 50+ year lows, as is GM.

What would a person do for their retirement as a result of that buy and hold hell?

2008 Nov 17 10:14 AM

[John Lounsbury:]

IMO, the debate about buy and hold (in its many personna) is less important than a discussion about the heralded Efficient Market Hypothesis. The essence of this hypothesis is that, on average, market timing can not be successful because the market is huge (all investors) and the market reacts instantaneously to all information as it occurs. Thus, it is simply a matter of luck as to which investors can profit from new news and the same investors can not repeatedly profit by following the news because the competitive investor population is simply too vast.

The hypothesis states that all new information is instantaneously incorporated into price so the average investor can not profit more than the market average because the sum of the average investors is the market average.

There are three fatal flaws in the Efficient Market Hypothesis.

(1) There are very few (if any) average investors. Therefore, applying the hypothetical average investor label to an individual has no reality.

(2) Much information is dis-information and the ability of investors to evaluate information varies widely. Sometimes there is a herd mentality to new news (correct and incorrect) and sometimes valuable news is slow to sink in to a wide audience.

(3) Some market action is due to "sentiment" and "emotion", which selectively emphasizes and ignores various news items.

If any readers have opinions regarding this famous theory (or is it hoax?), could we hear from them?

2008 Nov 17 10:45 AM

[robert.b.fe...:]

Buy and hold does not mean blinbly holding on to a loser just because you purchased it at a higher price than the current price. Some dogs need to be put down before they reach zero. Buy and hold works if you do due diligence, buy good companies especialy those with reasonably good dividends and prospects like (XOM). This strategy also works well in the context of dollar cost averaging such as 401K and IRA accounts especialy the ROTH version. However you should not have money in the market that you will need within five years.

2008 Nov 17 12:21 PM

[bigmoney:]

>> when the lines between saving and investing have been blurred

people are treating the stock market as a bank account. The trouble with that is demographics, where the baby boomer gen is much greater in number than those behind it. Buy & hold might be a good plan if the demographics was shaped like a pyramid, rather than an upside-down pyramid. I don't know what happens when the boomers start retiring in mass, liquidating stocks and mutual funds to pay for their retirement.

2008 Nov 17 06:15 PM

[Tibis123:]

This is a well written piece about the absurdity of the much publicized buy and hold strategy. I totally understand, through exprience, the difficulty of market timing but I also understand that companies competitiveness and growth opportunity change very rapidly in today's increasingly complex business environment, not to mention business disruption as a result of national and/or global econmic downturn. One must regularily research the company he/she is invested in and act accordingly. On the latest, an investor should review the companies standing in great detail on a yearly basis and make a decision on whether to hold or let it go.

2008 Nov 18 02:16 AM

[Chuck LeBeau:]

Buy and hold is not a strategy but is in fact the absence of a strategy of when to sell.

Now that there is mounting evidence of the failure of buy and hold the advocates of this very costly advice are trying to weasel out of their responsibility for such poor logic in the first place. Now we are receiving "qaulified' buy and hold advice like "buy and hold some stocks like XOM" or "buy and hold but sell the dogs" , etc, etc.

Give it a rest. Buy and hold was doomed the day it was invented because it fails to control risk. It fails to control the risk of bad stock selection and it fails to control the systemic risk of market like the one we are seeing now. It fails to recognize that the money invested needs to be there when you need it and it fails to recognize that markets don't need to be timed but risk does need to be limited by a real exit strategy.

Don't get me started on that ridiculous efficient market hypothesis. That's even dumber than buy and hold. Does everyone believe whatever drivel is published by an academic. What ever happened to good old fashioned common sense and a questioning mind? Let's get out of the theoretical world and back to reality.

2008 Nov 22 06:54 PM