The Last Word on Buy-and-Hold

Includes: BRK.A, BRK.B
by: Lollapalooza

The stock market has gone nowhere in the past twelve years. Naturally, this has renewed arguments that buy-and-hold investing is dead. This angle has been exacerbated by the general belief that high-frequency traders dominate today’s financial markets. From the point of view of many value investors, this argument is as pointless today as it has always been.

To help understand this argument better, let’s first decide what is meant by “buy-and-hold.” Much of the media focus appears to be attacking the notion of “buy-and-hold-forever,” an approach commonly attributed to Warren Buffett. As a side note, many believe Buffett uses this approach as much out of necessity as he does by choice. And there is nothing wrong with smaller individual investors employing this approach either. Over very long periods of time, the returns experienced by the business and its shareholders converge until they are roughly equal. However, very few businesses have “buy-and-hold-forever” qualities and very few investors hold for periods of ten or twenty years.

The buy-and-hold approach actually practiced by many other value investors is much different. Many value investors are prepared to buy-and-hold-forever because they are often taking advantage of a sort of time arbitrage; but they are also willing to take short-term profits when prices quickly rise above their estimates of fair value.

If an investor buys a stock at $25 believing it is worth $50, it very rarely makes sense to continue holding the stock if it goes to $60 three months after purchase. So in periods of extreme volatility, an investor may be mistakenly labeled a “trader” if portfolio positions quickly rise to fair value and are sold. And because value investors often talk about a long-term (buy-and-hold) approach, many people make the mistake of assuming positions are always held for long periods of time.

Yes, buy-and-hold failed investors over the past decade. However, closer examination will reveal that buy-and-hold primarily failed investors who owned cap-weighted portfolios from point to point. Most large cap stocks were grossly overpriced a decade ago and investors were handed poor subsequent point-to-point returns. However, there were plenty of opportunities to make money buying and holding over the past decade, as long as investors had flexible holding periods or invested in assets other than U.S. large cap stocks.

Perhaps the next decade will be even more volatile, leading to even higher portfolio turnover among traditional buy-and-hold value investors. Then the media will have its “proof” that buy-and-hold is dead, as they will report many of the great value investors having completely abandoned the practice.

Disclosure: No Positions