Like so much that comes from the crooked smile of Wall Street, there is just enough truth in this statement to make it sound credible.
First, it is true that “over time,” buy and hold works out for 30-year periods (before taking inflation into account, anyway.) And it works for most 20-year periods. Of course, as John Maynard Keynes observed wryly, “In the long run we are all dead.” If you’re 65 and living on a fixed income, it is rather a small comfort to know that, while you may now be eating cat food until you die, in the long term your children will inherit a portfolio that someday gets back above ground zero.
Second, Wall Street’s PR machine always crows that they believe in “long-term investing.” However. What they teach their brokers in training is to sell. After I left active duty and before discount brokering was allowed, I worked in the full-commission business. Our branch manager wore 3-piece suits, spoke earnestly, shook hands forcefully, and took clients out on his yacht to impress them with how well they could do by investing with our firm.
Dr. Jekyll became Mr. Hyde, however, the moment the clients were gone. “There’s an extra dime a share in this dog for anyone who dumps more than 1000 shares in the next hour,” he’d howl, referring to some IPO or secondary the firm had gotten stuck with. “Churn and burn” was the name of the game and the marching orders were to sell whatever had gone up (“you can’t go broke taking a profit”) or to sell whatever had gone down “to move into something better.” The goal was turnover. Wall Street says one thing in their literature (“Invest for the long term”) but another to their brokers (“The more you turn, the more you earn.”)
Finally, you’ll note when they say, “Buy and hold is the best strategy,” they don’t say for whom the strategy is best... It is the best strategy for them so they can day-trade without a bunch of amateurs getting in the way! Wall Street knows they can’t fool everyone into being churned, so they have found a win-win for themselves from among those who buy and hold. By providing them your cash balances, and your stocks they can loan to other firms or use to lever their assets, they can comfortably program-trade, buying and selling in nanoseconds all day long. (See here for more on program trading.)
If buy and hold is so desirable, why are there no long-term holdings in Wall Street’s portfolio? “Long-term” to Wall Street is: the public sells shares in despair all day. At 3 p.m. we equal their earlier volume by buying wildly on the 30 (or for the S&P) 50 or so stocks with the ability to move the market indexes the most. Then when the pigeons decide they’re missing something and want to buy, we sell what we just bought right back to them.
Yep, buy and hold is very good for Wall Street. But is it good for you and me?
Maybe. If you have the luxury of taking a truly long view – like you’re twenty years old and these funds will remain in an IRA until you’re 59 ½ , maybe. Or if you’re independently wealthy and you want to leave a big nest egg to your kids or to the foundation you’ve established, maybe. If upscale cat food is likely to be a possible dining choice if your portfolio declines, however, clearly not.
Here is a recent chart courtesy of Sy Harding of Street Smart Report. Sy is consistently ranked one of the best market timers around. Here, from his superb blog is a chart indicating why he believes at least the occasional entry and exit from the markets is necessary. Please note where buy and hold investors stand…
That’s right. If you are 50 today, your buy and hold portfolio is worth roughly the same as it was when you were 38. Whether your stock picks mirrored the market or whether you fell for the index funds pitch and invested $10,000 in your 401k in an S&P 500 index fund when you were 38, that $10,000 is worth today: $10,000. Think $10,000 today will buy the same gallon of milk or gallon of gas it did back then?
I believe there is a smarter way. For me, there are three components to building a successful portfolio: periodic rebalancing (not to be confused with trying to time the market’s daily ups and downs,) intelligent asset allocation and, finally, exceptional stock selection.
Buy-and-hold investors typically spend 0% of their time, energy and intellect on periodic rebalancing; 0% - 30% on asset allocation, and 70%-100% on stock selection. If they are mutual fund investors, they devote 0% on any of these, trusting the mutual fund managers to do all that. The same mutual fund managers whose typical turnover is 100% a year. You may buy and hold the mutual fund, but they are churning its portfolio mercilessly. That’s hardly buy and hold!
When the markets decline, they take the good and the great down right alongside the bad and the worst. Partly this is because of investor panic, more is because of the fact that institutional money managers are paid for performance. To keep their bonuses coming in, they’ll sell their mother if it will offset a loss that would otherwise place them below their “benchmarks.”
This creates a waterfall effect and brings everything down, good, bad, ugly, or magnificent. In bear markets, buy and hold means hoping it will turn around while calling it a “strategy.” One of our clients quoted a headline today in a phone conversation that sums it up rather well: “Hope is Not a Strategy.”
By periodically rebalancing, you don’t have to “know” when to buy and sell. You don’t have to “time” the top or bottom. If you periodically rebalance, you simply take a little off the table when the news is universally sunny and priced for perfection. You step back in when the world is allegedly coming to an end. You won’t get it right every time but you aren’t risking your entire portfolio on a single bet, either. And you’ll do better than buy and hold or day trading. (See here for more on this…)
It’s the same with stock selection. Right now I’m looking forward to buying the best sectors, which for me will include energy, agriculture, mining, and the raw materials that nations like Canada and Australia will supply to developing economies like India and China. I can’t wait until Deere (NYSE:DE), Syngenta (NYSE:SYT), and Lindsay (NYSE:LNN) in agriculture, or Imperial Oil (NYSEMKT:IMO), Chesapeake (NYSE:CHK) and Exxon (NYSE:XOM) in energy, BHP Billiton (NYSE:BHP), Major Drilling (OTCPK:MJDLF), and Vale (NYSE:VALE) in mining – to name just a few – decline to great buy points. But I won’t buy at just any price and I don’t hold them through a major decline.
If you feel a need to buy the fuel for mutual fund or Wall Street execs as they helicopter between The Hamptons and their offices, they won’t mind a bit. After all, if you remove some money in every bear market, protecting yourself from further declines, their bonuses would plunge to nothing. Some would even lose their cushy jobs. Of course they tell you that buy-and-hold is the way to make money!
That said, where do we stand today? I believe that red neon light is flashing. Too many people are whistling “Happy Days are Here Again.” I think they’re whistling past the graveyard. We are in income, cash equivalents like short-term bond ETFs, and short via inverse ETFs. If you disagree, you may want to buy “banks” like Goldman Sachs (NYSE:GS), Morgan (NYSE:JPM), Citicorp (NYSE:C) or Bank of America (NYSE:BAC). I’ll be shorting them.
I regret to report that there are other, equally egregious, Fractured Fairy Tales. Here are some I will discuss in follow-on articles:
#2 – Less Bad News = Good News
#3 – Program Trading Stabilizes the Markets
#4 – Discount Brokers Can’t Provide What We Provide
#5 – Short Selling by Individuals is Bad for the Market
#6 – Our Analysts Provide Unbiased Coverage
#7 – Now That We’re a Bank, Your Money is Safe
#8 – You Don’t Pay a Commission for Bonds, IPOs, Secondaries, etc.
#9 – Your Broker is a Keen Observer of the Markets
#10 – Investing is Too Difficult to Do On Your Own
Full Disclosure: We are long a few bank and healthcare preferred shares that we believe still offer good value and high yield; we are long option-writing closed-end fund GGN because, through thick and thin, we like their portfolio of gold and energy companies; we own lots of cash equivalents (our biggest positions) in short-term bond funds like SHY and TUZ and slightly longer-term (5-10 years) BND, AGG and TIP; and we are short, mostly via inverse ETFs like SKF, SRS, SBB, EUM, PSQ, SH, and DOG.
The Fine Print: As Registered Investment Advisors, we take our responsibility seriously to advise that, since we do not know your personal financial situation, the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Past performance is no guarantee of future results, and it should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Finally, we will always disclose whether we own or are buying the investments we write about.