In Defense of Buy and Hold

Recently, it has become very popular, to deride buy and hold as a strategy for investment. It is reasonable to ask how much of this change in investment philosphy is a result of the losses that most of us experienced from late 1997 through 1998. and how much is the result of more rational insight.

Those who still support buy and hold, focus on the difficulty of timing the market; and those who disagree with buy and hold focus on the need to time the market in order to have consistently good returns. Clearly, almost anyone can time the market well some of the time, the important question is how frequently does this occur. Or, what is the probability that a decision to time the market will in fact be a good decision. There is a simple way to answer this question.

Whenever the market reaches a peak as it did in October 2007, the peak in the market prices is also a peak in the amount of money invested in the market. Whenever the market reaches a (local or recession) bottom as it did in March 2009, that bottom also corresponds to a time of the least money invested in the market.

From these two facts we can conclude that the average equity investment that attempted to time the market was bought back higher than it sold. That is, the buy and hold investor did better than the average investor who did not buy and hold.

A simple mathematical model using differential equations or monte carlo methods could be written to estimate the percentage of trades which did better than buy and hold, but I will leave this task for another.

When the next downturn occurs, I hope to do better at getting out of the market early, and returning near the real bottom than I did this time, but the odds of my succeeding at this are very poor.

Comments

[Jasper M:]

Using the author's methodology, if 52% of all marriages end in divorce, one should not bother to marry.

Using the failure of an average participant as an excuse not to apply one's intellect to an issue is defeatism. And defeatist prophesies tend to be self-fulfilling.

I strongly suspect that those willing Try market timing are more likely to learn how to optimize their approaches over time then those who start with a "buy and hold" approach, as holding implies implies a considerably more passive approach, inviting inaction.

I confess my biases: I have made a fortune timing, after losing a (smaller) fortune holding. And I cannot imagine how a bias for holding can serve one well in an environment of an overall decline that threatens to have generational duration.

Jun 15 05:24 AM

[drevno:]

What is missing is a meaningful definition of the duration of the "hold" portion of the buy-and-hold (BAH) strategy. For some it may be weeks or months, for others maybe years; and for some others it may be reaching some predetermined value of the share or a specific event that triggers the sell. Without such a definition a meaningful debate lacks both the necessary focus and the metrics.

Secondly, the BAH strategy is in some respects similar to the "fire-and-forget" method of the army: your fire your missile ("buy") and the device - with some or no intelligence - is hopefully going to hit the target ("holding"). The probability of success is rather variable, based on the quality of the device (the share), the moment of firing it (the timing of the buy) and the elusiveness of the target (market conditions as well as the results of the target company at the time of the eventual sell). Hence, the somewhat fire-and-forget BAH investing strategy may be suitable for investors with either limited ability to manoeuver their investments on a daily or a short-term basis, or have information or faith leading them to believe in the value of a long-term holding of a specific share or an index, e.g. based on some long-term trend or a prospect for a specific commodity or product.

On the opposite side are investors whose strategies are based on exploiting short-term technical movements, or have specific information generally not available on a timely basis to the BAH type investors.

It would appear that in the times of heightened volatility, market timing may offer greater short-term gains. Or losses. Hence, the market timing activity would not generally appeal or be available to the majority of investors, who would prefer less frequent involvement with their investment and are prepared to accept potentially lesser returns.

The problem remains with a degree of risk: neither market timing, nor BAH strategy offer certainty of returns. The difference is only in timing: the BAH may take longer to ascertain the success of investment - for the day traders all is clear gratifyingly quickly!

Jun 15 06:10 AM

[Jim Hawthorne:]

I am in agreement with Jasper M above! There is neither excuse nor rationale for accepting crippling losses through the use of a strategy which owes it's following to the experiences of the last century and ignores present market trading realities!

There is a huge difference between 'timing the market' and 'trend following' based on a combination of fundamental and technical analysis! While timing exact market tops and bottoms may be a fool's errand, recognizing trends through careful analysis is not, and watching the direction 5, 10,15,25,and 50 day moving averages will tell you most of what you need to know.

'Buy and Hold' cannot only be called a lazy man's strategy; it really is no strategy at all!

Jun 15 06:19 AM

[SimpleVesting:]

The author's logic is amazingly weak. See Jasper M' comment above. He already said what I would have.

Jun 15 09:54 AM

[Dave Shafer:]

The fundamental problem is not the issues with the strategies [and there are issues with each strategy], but that the evidence is clear that folks don't follow the strategies. A majority of buy-and-holders sell into a bear market and buy into a bull market [classic sell low, buy high]. Human behavior ignored results in poor performance more than issues with the strategies. The more passive a strategy the higher the likelihood of emotional responses.

Jun 15 09:55 AM

[swaps:]

I mostly buy and hold, but the responders on this board have truly pointed out the foolishness of that. Of course, the market already has ponted this out too.
The problem is that traders and market maker specialists continually drive stocks to levels above and below intrinsic values even in relatively stable times..
It's lilke the coin clipping of midieval times. A buy and holder is continually subjected to having the value of his holdings clipped by the highly motivated bright minds.
Still, despite the markert collapse eight or nine of my 20 holdings are above or near what I paid for them, when factoring in dividend income. These are purchases within the last one to four years.
So in half my portfolio buy and hold beat the DOW, but the losses in my broader holdings naturally offset that because some of these were crushed.
You can buy and hold a Kinross Gold, a Unilever, a Jefferies Securities, but not Allied Irish Banks, New Ireland Fund or Brandywine Real Estate.
So it looks like buy and hold can be selectively applied, as can short term trading.
Too late have I figured that out.

Jun 15 10:23 AM

[AndrewBaker:]

Buy and hold would not have done much for a Japanese home-land investor 20-odd years ago when the market stood at 40,000. It's great when the trend keeps going up, albeit at a slower rate sometime than others, but rubbish strategy when a big downturn takes 20+ years to not even recover - as in Japan - and that is why trend following is infinitely better.

You can sell your best stocks when they drop to your stop-loss, and buy them back later. Even if the buy-back price is higher, the difference in cost plus dealing is simply an insurance premium against wallowing for 20 years, going nowhere and losing due to inflation.

Jun 15 02:24 PM

[Old Trader:]

Although I started out as a BAH investor, over time, I modified my approach out of necessity. Now, I run a "dual" portfolio comprised of a "core" portfolio, augmented by a smaller "trading" portfolio. Even within the core portfolio, I may trade "around" certain positions, underweighting, or overweighting, depending on where/how I perceive things to be going, from a fundamental standpoint, both company specific, as well as from a "big picture" point of view. Btw, my defintions of short term is 12 months, or less, intermediate is 12-36 months, long term is 36-60 months.

As mentioned above, there are numerous strategies that can be employed to invest/trade in the market. Some are better suited to certain market conditions. An investor has the choice of either finding the "style" that best suits them, and employing it consistently, with the understanding that, under certain conditions, he'll "underperform". The much harder alternative is to become at least reasonably adept in various strategies, and being able to figure out which one is best suited to the current conditions.

Jun 15 08:05 PM

[a. palmer jr.:]

If I were a buy and hold-er I would have about 1/3 to 1/2 of my retirement plan now. I sold my mutual funds right when the markets started to tank. At my age, buy and hold isn't exactly an option.

Jun 15 08:14 PM

[untrusting ...:]

Swaps,

It's not that hard. The above posters that explain following trends and/or moving averages are 100% correct. What is important is to catch the major changes in trends. If you go to dhshort.com and read what he has (free) and his analysis you will understand. His site is excellent and shows lots of valuable free information. If you had followed his moving average indicators, you would have been totally out of the market in in Dec/08 or Jan/09 and saved yourself a fortune. Imagine being totally out of the carnage with all your 2008 profits locked in. So I certainly would agree that buy and hold is essentially worthless. Thus the point is, as doug short points out, to catch most of the upside and miss most of the downside. If you can do that, you will far far far outperform most investors including the so-called experts. Nobody and I mean nobody catches all of the upside and misses all of the downside ... as that is more luck than smart investing.


On Jun 15 10:23 AM swaps wrote:

> I mostly buy and hold, but the responders on this board have truly
> pointed out the foolishness of that. Of course, the market already
> has ponted this out too.
> The problem is that traders and market maker specialists continually
> drive stocks to levels above and below intrinsic values even in relatively
> stable times..
> It's lilke the coin clipping of midieval times. A buy and holder
> is continually subjected to having the value of his holdings clipped
> by the highly motivated bright minds.
> Still, despite the markert collapse eight or nine of my 20 holdings
> are above or near what I paid for them, when factoring in dividend
> income. These are purchases within the last one to four years.<br/>So
> in half my portfolio buy and hold beat the DOW, but the losses in
> my broader holdings naturally offset that because some of these were
> crushed.
> You can buy and hold a Kinross Gold, a Unilever, a Jefferies Securities,
> but not Allied Irish Banks, New Ireland Fund or Brandywine Real Estate.
>
> So it looks like buy and hold can be selectively applied, as can
> short term trading.
> Too late have I figured that out.

Jun 15 11:55 PM

[untrusting ...:]

Exactly right. One has to wonder why these so-called bright mutual fund and pension fund mangers who collect big fees and manage so much of the LT passive wealth are either too lazy or too stupid to see that. One would think that with their massive resources, full-time investment staff, and so-called superior investment background that they would be able to see that. But apparently either they don't or they don't care, not sure which.


On Jun 15 06:19 AM Jim Hawthorne wrote:

> I am in agreement with Jasper M above! There is neither excuse nor
> rationale for accepting crippling losses through the use of a strategy
> which owes it's following to the experiences of the last century
> and ignores present market trading realities!
>
> There is a huge difference between 'timing the market' and 'trend
> following' based on a combination of fundamental and technical analysis!
> While timing exact market tops and bottoms may be a fool's errand,
> recognizing trends through careful analysis is not, and watching
> the direction 5, 10,15,25,and 50 day moving averages will tell you
> most of what you need to know.
>
> 'Buy and Hold' cannot only be called a lazy man's strategy; it really
> is no strategy at all!

Jun 16 12:04 AM