Buy And Hold Is Dead You Say?

by: Eddie Herring

I love to read and I read a wide variety of books, magazines, newspapers, financial/investment articles, Seeking Alpha articles, etc. One of the recurring themes and comments I run across in financial/investing articles is that buy and hold investing is dead. That really surprises me because I wasn't even aware it had been ill, much less in the bony grasp of the Grim Reaper.

Admittedly these articles have a little different concept of buy and hold than I do. They typically portray buy and hold as buying a stock or business, and then holding it for years and years while the price ever so slowly goes up. Then the articles/comments will explain why that is no longer a viable method, often citing Kodak or Enron as examples of why it no longer works.

A Buy and Hold Is Dead Argument

A late September article I read referenced a recent article in the MIT Technology Review and used that article to put a little different spin on it. It noted how the lifespan for companies being listed on the S&P 500 is shortening, and illustrated it by the chart below.

What the MIT article noted was that in 1958 companies could expect to stay on the S&P 500 list for 61 years and today it is 18 years. Since the list wasn't started until 1957 I'm not sure how a company would expect in 1958 to be on the list 61 years later. However, while the MIT article admitted no one really knows why the turnover rate is shortening, it noted that a number of the companies removed from the list had failed to keep up with technological innovation. The author of the "Buy and Hold Is Dead" article then used that turnover rate to make his case. I think it's quite a stretch though and, to be quite frank, I don't buy it.

The S&P 500 is made up solely of large cap companies. The criteria for inclusion is being a U.S. company, having a market cap of at least $4 billion, at least 50% public float, meeting certain financial viability, liquidity, and sector requirements, and being an eligible company type. CEFs, ETFs and ADRs are not eligible for inclusion but REITs and BDCs are, along with, of course, the common NYSE and NASDAQ C Corp. type equity companies.

The S&P may remove companies that "substantially violate one or more of the criteria for index inclusion" or they're "involved in merger, acquisition, or significant restructuring such that they no longer meet the inclusion criteria." In theory a nice sized market pullback during a recession could knock some companies out of the index because of stock market price action. But that alone doesn't necessarily mean the company is no longer a viable investment or an inferior business. Removal from a list doesn't make it a dead investment.

S&P has other lists it maintains, including the S&P 100, 400, 600 and 1500, as well as individual sector lists. To my way of thinking, inclusion or exclusion alone doesn't have much bearing on the investment value. The fact that only one company, General Electric (NYSE:GE), has been listed on it for its entire existence should indicate its value as a metric for "buy and hold" investments is limited. To be a candidate for a long-term investment in my portfolio they must first meet my specific investment criteria and while I may look at market cap, I'm much more interested in the criteria that align with my goals as a dividend growth investor and retiree.

My Concept of Buy and Hold

Each of my investments has a planned timeframe for holding months, years or even cycles. Those considered buy and hold are intended to be lifetime investments. I stated earlier that my concept of buy and hold was different so let me first say what it isn't. Buy and hold is not buy and forget, nor is it buy and ignore. We shouldn't expect to be like Rip Van Winkle and invest and wake up in 20 years and be surprised things have changed.

Some people refer to it as buy and monitor. In my opinion, that should be a given for any investment. Where the difference lies is in what specifically would cause you to stop holding. For many people it is price fluctuation. For me it's what the underlying business is doing in areas such as earnings, cash flow, product performance, moat protection, dividend growth and safety, etc. Put a different way, buy and hold means I'm buying a specific business and holding it until it's no longer a valuable business, no longer meets my objectives, or I find a better business to own. To repeat, it's not "set and forget."

I stay cognizant of price trends but I'm certainly not like one technical analyst who I heard say "never let the fundamentals get in the way of an otherwise bullish technical setup." Whether the company is making a profit, paying a dividend, and can continue paying the dividend means much more to me than if it's at a certain Fibonacci level or is forming a Japanese candlestick Doji pattern. That allows me to view price pullbacks and buying opportunities, but if the underlying fundamentals deteriorate then it is time to reevaluate the holding.

By monitoring a company's business fundamentals, both the financial side and the "art side" (management/products/organization) as I call it, one can determine when a company becomes "at risk" and bears closer watching as a long-term investment. Both of the above referenced articles mentioned Kodak as an example and this article, using Kodak and Microsoft (NASDAQ:MSFT) as examples, gives my take on how to spot when a long-term investment is potentially at risk. While you may not be able to anticipate a British Petroleum (NYSE:BP) type of incident, proper monitoring can spot a Kodak moment coming.

A Buy and Hold Is Alive Argument

Taking the opposing side of the buy and hold is dead discussion means asking "if buy and hold is not dead, how do you know it's alive?" There are a number of ways to answer that, including running historical studies on overall performance of a large number of companies. But that would require deciding which companies, time frames, performance criteria, etc., and dealing with potential survivorship bias issues. To keep it simple, I decided to look at my own portfolio.

Probably the most common metric used for determining if an investment is working is total return. It's not the only one but is the one most often cited by a majority of investors/advisors. I have no issues with using total return to gauge an investment's success or lack thereof, but to be quite honest it's not the most significant to me. I view it though as being multi-lingual, by which I mean if someone wants to talk in terms of total return, fine, we can have that discussion using those terms. But as a retired dividend growth investor, I prefer to converse in the language of income which is the most important metric to me. As Will Rogers said "I'm more concerned with the return of my money than the return on my money."

Using a total return approach I decided to look at 20 years as the buy and hold time period since not only is it a sizable period of time but also covers the internet bubble, housing bubble and the recent great recession of 2008. While I currently have 33 positions in my portfolio, only 19 of them have been publicly traded 20+ years so I pulled data using those 19 companies. Using the Low Risk Investing Site and the period from October 1993 through September 2013, the SPDR S&P 500 (NYSEARCA:SPY) had a compound annual growth rate, or CAGR, of 8.7%. Only 1 of the 19 companies had a CAGR less than that, with Waste Management (NYSE:WM) having a CAGR of 8.1%. Here is a table of those 19 companies with their CAGR for the 20 year period.

However, as I said earlier my focus is on the income I'm receiving from my investments and accordingly the metrics I'm most interested in are those that reflect the income approach, such as dividend growth rates, or annual, quarterly, and monthly income growth. In tracking my investments it's more important to me that my income increased 15.70% in September 2013 when compared to September 2012, or that through the 3rd quarter of 2013 my income was up over 24% compared to the same period last year, than if my return matched the S&P. The stock price return of a company can fluctuate but provided the income is still going up and the company is still an excellent business to own, I'll continue to hold and be content. Admittedly not everyone looks at price fluctuation as I do.

As a disclosure not all of these companies have been held the same amount of time. However, I selected these companies for my portfolio with the intention of holding for the long term. If I was to make 19 buys today they may or may not be the same companies. But more than likely companies like Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), Chevron (NYSE:CVX), McDonald's (NYSE:MCD), Norfolk Southern (NYSE:NSC) and similar would still be selected. While I evaluate what they have done in the past I buy them based on what I think they will do in the future, which means I think these quality companies will continue paying and growing dividends and creating income growth.

Is Buy and Hold Still Valid?

It is my belief that when you invest in a business that is well managed and performs well from a business standpoint, i.e. increasing earnings, cash flow, profits and increasing the value of the company, that the stock price will eventually follow along with the value of the business. That means by focusing on income and dividend growth I get capital appreciation/total return along with the income. But the investor must be patient, hence the term buy and hold. But do most investors do that?

According to a recent research report released by two University of California professors, Barber & Odean, titled "The Behavior of Individual Investors" (pdf available here), most investors behave differently than finance models such as the Capital Asset Pricing Model call for. In other words, investors respond differently to real life situations than they do in the academic classroom. That should not come as a surprise.

According to their research, individual investors trade too frequently, which creates excessive transaction costs, and it was noted they seem to lose money on their trades even before costs. They also state that one analysis of 78,000 investors provided compelling evidence that individual investors' self-managed stock portfolios underperform the market largely because of trading costs.

Additionally, they indicated investors have poor stock selection ability, sell winners and hold losers, have poorly diversified portfolios, and are unduly influenced by media and past experience. Poor stock selection ability tells me most investors either don't do due diligence when selecting companies, or they don't know how, and they overpay. Selling winners and holding losers are the fear and greed emotions controlling the investor rather than the investor controlling them. Poor diversification can lead to significant draw downs, which triggers fear and encourages taking losses. The media is a constant influence on over trading (suggestion - turn off CNBC), and people will avoid certain valid investments because of past bad experiences. It's like the old story of the cat that sat down on a hot stove, it will never sit on another hot stove, but it will never set on a cold stove either.

According to their report the empirical evidence indicates that the majority of investors, in the aggregate, would be better off to invest in a low cost index fund. If they're unable or unwilling to do the work necessary for proper stock selection, I would agree. But with an annual turnover of 250% for the 20% most active investors (according to one dataset) in "non-speculative" trading, it would appear that over trading is a major contributor to those showing losses. Successful investing, in my opinion, takes work, discipline, patience and time. Over trading is a sure way to lose money.

In the conclusion to their report Barber and Odean state that "individual investors who ignore the prescriptive advice to buy and hold low-fee, well-diversified portfolios, generally do so to their detriment" (emphasis mine). If buying and holding is the way to go, why do investors not do more of it? The answer to that question would probably be worthy of a research report itself, but here's my opinion.

I believe the problem most investors have with buy and hold is that they don't have the discipline required for the actual act of holding. They allow outside influences to affect the emotional aspect of long-term holding that is required to be successful. Holding a stock over a long term means that one will have to endure the stock price fluctuations that will naturally occur over a long holding time. This requires discipline, including the discipline to focus on the underlying business, resist outside influences, and make rational business decisions.

When the media is constantly prattling on about stock volatility and various financial outlets are bombarding individual investors with the latest and greatest trading hooks, investors too easily give in to these temptations and wind up over trading and lose money. With modern society's instant gratification mindset it is easy to give in to the get rich quick schemes.


I'm not knocking other specific investment strategies. There are lots of different ways to make money in the stock market. But there are an equal number of ways to lose money as well. Investment strategies should be selected to match one's personal objectives and timeframes along with matching their individual skills, personality, character and emotional traits - as a retiree though I want to "be retired." It would be a mistake for me to try to be an active trader trying to grasp the next big thing. I have better things to do with my time and quite frankly, my most profitable positions have been those where I just sat on my backside and watched the dividend income roll in. But I also believe buying and holding a portfolio of quality companies paying growing dividends works just as well for those not yet retired, especially when the dividends are reinvested within the portfolio.

Investing is not a 1 mile, 5k or 10k race to the finish line, it's a marathon, so while buying (assuming paying a fair or under-valued price) and holding quality dividend growth stocks, and letting compounding work its magic may be the road less traveled, for me it is the way to go. It worked for Benjamin Graham in 1949 and it is still working 64 years later. In regard to buying and holding being dead, let me paraphrase the line attributed to Mark Twain. The report of its death is greatly exaggerated.

Disclosure: I am long CVX, JNJ, MCD, MSFT, NSC, PG, WM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds.

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