Well, it looks like the trumpet has sounded again. Buy-and-hold is dead, out-of-touch, out-of-date, and out of whack. The latest alarm bells on the topic have come from Andrew Lo, an economist and finance professor at M.I.T.'s Sloan School of Management. In an interview with Charles Wallace at Money, Lo argues that technological change and market volatility have altered the investment landscape, making the old-fashioned notion of buy-and-hold investing obsolete. Here's what Lo had to say on the subject:
But doesn't a simple buy-and-hold strategy address a lot of these issues of risk?
Buy-and-hold doesn't work anymore. The volatility is too significant. Almost any asset can suddenly become much more risky. Buying into a mutual fund and holding it for 10 years is no longer going to deliver the same kind of expected return that we saw over the course of the last seven decades, simply because of the nature of financial markets and how complex it's gotten.
So what choice do I have instead?
We're in an awkward period of our industry where we haven't developed good alternatives. Your best bet is to hold a variety of mutual funds that have relatively low fees and try to manage the volatility within a reasonable range. You should be diversified not just with stocks and bonds but across the entire spectrum of investment opportunities: stocks, bonds, currencies, commodities, and domestically and internationally. Most of us didn't sign up for the kind of volatility we're seeing right now. So keep in mind that if you're holding equities, you are probably taking more risk than you thought.
My concern with Lo's argument is that he defines risk as volatility. That is not how I think investors are best suited measuring risk. Rather, I'd argue that risk should be measured as the likelihood that an investment will lose purchasing power over a contemplated holding period. For instance, Coca-Cola (NYSE:KO), Pepsi (NYSE:PEP), and Johnson & Johnson (NYSE:JNJ) have some of the safest business models that exist in the world. But if you're contemplated holding period is one year, they are very risky assets-there's no telling what a soda firm will be trading for next June.
But if you plan on holding Exxon (NYSE:XOM) for the next ten years, the investment risk is much, much smaller. The only way that you would lose purchasing power is if the earnings and dividends do not grow over that period of time or if the market values Exxon at an absurdly low multiple like four, five, or six times earnings. And if, as an investor, you have an indefinite holding time, you remove the latter risk and can focus on earnings and dividend growth.
I've never really connected with the fellow writers on Seeking Alpha who brag about their low beta stocks and see volatility as a measurement of risk. Let's say that I own a local storage unit that generates $100,000 in annual profits from 250 clients. If one day one an investor offered me $50,000 to buy my business, on day two an investor offered me $1.2 million to buy the business, and on day three an investor offered me $300,000 to buy the business, my volatility would be off the charts.
But I don't measure risk by the intelligence or folly of others (i.e. the market participants). Instead of worrying about something like beta, I would worry about the likelihood that I would lose some storage units clients, have to charge lower monthly fees, and of course, the biggest risk of all is that another storage unit firm touches down next door. It's the same thing with stocks. If I know ConocoPhillips (NYSE:COP) is worth $65 per share, then who cares if the bozos (collectively, the stock market participants) are only offering me $50 to buy my stake in the firm? I'd hold them in a similar regard to the investor who underbids my storage unit.
I was also surprised by Lo's line that most of us didn't sign up for the kind of volatility that we're seeing right now. I don't know what advisor tells his clients that 20, 30, 40% stock declines are not part of the price of admission for reaping the benefits of long-term stock market investing, but a look at the annual performance of the 20th-21st century American stock market should prepare prudent investors for stock market fluctuations. The Dow Jones (NYSEARCA:DIA) fell 52% in 1931, 33% in 2008, and 28% in 1974. This has always come with the territory.
Interestingly enough, I do think there is a criticism of buy-and-hold investing to make. And that's that many of the moats that existed during large portions of the 20th century have been filled up with sand. One only has to look at newspapers, TV stations, automobiles, and airlines to see that's the case. There was once a time where 100 shares of The New York Times (NYSE:NYT) was providing integral dividend income for a retiree. Several grandchildren of General Motors (NYSE:GM) autoworkers had to watch as their million dollar trusts turned into dust because their grandfather included the instruction, "Never sell the GM stock" as part of the will. If you died in 1965, you very reasonably could have considered Ford (NYSE:F) as safe of a stock as Procter & Gamble (NYSE:PG). Warren Buffett once lauded the durable moat of CBS (NYSE:CBS) in the 1960s. The rapid rise of competition that an open world permits and the mind-boggling rate of technological change has affected the buy-and-hold landscape. But it's foolish to take that sentiment to the next step and conclude that no stocks fit the buy-and-hold mold.
The notion that we can buy a stock and hold it indefinitely is a major commitment for us as investors to make. As such, we need to be highly discriminating in our selections before making a long-term decision. If I'm going to own something for twenty years or more, I want the excellent business to have: wide moats, low debt, diversified sources of revenue, wide product exposure, the ability to withstand technological innovation, and the strength to raise prices to combat inflation.
And there are firms out there that meet that criteria. Coke, Colgate-Palmolive (NYSE:CL), and Kimberly-Clark (NYSE:KMB) generate profits in dozens of currencies, sell dozens of different products, have low to moderate debt, and have tremendous economies of scale, making it difficult for new upstarts to undercut their business models. These firms are stronger than they were 10 years ago, and ten years ago, they were stronger than they were twenty years before that. There are mega-cap firms that move from strength to strength. That's why I reject the notion that buy-and-hold is dead. Critics of the practice would be better served noting that the universe of buy-and-hold investments have narrowed, and prospective buy-and-hold investors should be discerning in their selection of potential buy-and-hold investments.