Is Buy and Hold Dead?
The Great Debate
Many of you are participating in the Buy and Hold debate on Fool.com. It’s inevitable in a period of sharp market decline that the anti-buy-and-hold crowd inspires a bacchanalia ritual to liberate the long-term investing crowd from their restrained indexing and buy-for-life market strategies. But beyond the hype that accompanies a market crash, I think this is an important and enduring debate that persists throughout our investing lifetimes. It’s a debate, in my opinion, in which there’s a lot of merit on both sides, and I’m sure you will become a better investor if you are willing to challenge the conventional wisdom of either investing approach. As Buffett said about times like these, “profit from folly rather than participate in it.”
With the idea that you can make market volatility your friend rather than your enemy, the Fool will be sponsoring a series of articles to look at both sides of this debate, and I thought it would be a good idea to cover the action here in my CAPS blog. I hope we’ll have a good discussion here in my blog as well as join the debate taking place on Fool.com. Extreme and nuanced points of view welcome.
For a primer on the arguments on both sides of this debate, see the second half of this blog post. And I’ll continue to update this blog as new pro or con Buy and Hold articles are published.
In Tom Gardner’s initial article on the subject, Long-Term Investing Doesn’t Work, (don’t jump to conclusions about the title) he argues that LTBH investors must master the “four t’s” or they should not practice buy-and-hold investing:
1. Temperament. Can you stomach a 50% loss in the value of your investment portfolio over a two- to three-year period?
2. Time frame. Can you handle 10 years of zero returns from your investments?
3. Training. Are you capable of investing in public companies, diversifying internationally, and understanding what you own?
4. Tacking on. Are you inclined to add new money along the way, particularly as prices fall?
For those with shorter time frames, or those who seek maximum gains without the roller coaster ride from market peak to trough, he argues that volatility control, the diversity of trading ETFs, and options can provide a smoother ride as well as market beating returns—which is the strategy behind Motley Fool Pro.
This initial article in the series sparked lots of spirited discussion, and inspired zlog’s excellent blog, entitled “It works!” a defense of buy-and-hold, particularly in our current market…
Quotes from the Fool.com Debate on Tom’s Article
Buy and hold is not dead, its as relevant as ever. Tthere are three types who say buy and hold is dead 1) Tthose who profit from increased transactions, 2) those who want your $ for their advice and 3) Those who are experts at day trading, because they welcome another fool into the arena who thinks they can be good devoting 6:30-7:30 PM nightly to try to do better than average.
Now that does not mean that the landscape does not change occasionally, and that you need to live with your picks forever, but we live in a time where "noise" AKA everyone has a voice and really wants us to hear it and this wonderfull thing called the internet enables me to talk to the world, that we must be incredibly selective about what you listnen to, and what you react to and recognize that others will react to dumb stuff, and that will cause short term volatility that will drive a buy and hold nuts
In my opinion, the buy and hold days are over. That does not mean you should become a day trader, but modern technology is changing so fast that the probability that any one company is going to be the top dog forever is very low. I now set stop losses on every stock I buy and if it drops significantly it automatically sells. If it turns out I should have kept the stock, I can buy it back again for $7 on many on line sites. I will never again let my portfolio drop significantly based on predictions from so called stock experts, that on reality don't know any more than I do.
People forget several aspects of buy and hold.
Buy and hold needs to be used in value situations. You can't buy a commodity stock on the run up and expect to hold it long term. You can't buy a cyclical and expect to hold it long term. By the same token, you can't buy a mid-cap growth stock at 50 times earnings and expect to buy and hold. If the market turns, you'll get trampled, and at high valuations spectacular performance is priced into the purchase.
On the other hand if you buy a company with little debt, good cash flows, and a historically strong dividend record at a reasonable price, you can expect to hold long term until those fundamentals change. Buy and hold doesn't apply to speculative purchases.
People also tend to look at their patience with their funds and ignore the behavior of their fund manager. They may be "buy and hold forever patient" but their fund manager may not be. He's buying. He's selling. It's his strategy that you're using. So, buy and hold just doesn't necessarilly fit with mutual funds either.
Buy-and-Hold vs. Market Timing Primer
As I mentioned in the opening to this blog, there’s a lot of hype around the Buy-and-Hold vs. Market Timing debate. But forget the hype, you need to constantly evaluate the opportunity to hold vs. sell, and to understand the margin of safety associated with each of your portfolio positions and portfolio as a whole.
Here are the 3 of the most important issues to keep in mind as you evaluate risk and return in any market.
1. You will win with LTBH over a 20-Year investing period.
Source: Schwab Center for Investment Research Figure 1: Range of S&P 500 returns, 1926-2005.
Maybe the next 20 years will be different, but historically, including leading up to and coming out of the Great Depression, investors can’t lose over a 20-year investing time frame—and you are almost certain to beat the risk free rate of return. 18% annualized returns over your investing lifetime ain't too shabby.
2. If you’re not in the game, you won’t win big.
Source: Schwab Center for Investment Research, S&P 500, 1996-2005
A small number days drive much of the return—strengthening the argument that market timing can be risky.
3. But it’s also true that market timing can work.
Pu Shen Federal Reserve Bank of Kansas City has written one of the more interesting articles on Market Timing (http://www.kc.frb.org/Publicat/reswkpap/pdf/rwp02-01.pdf). A typical “common sense” approach to the Buy and Hold vs. Market Timing debate is to argue that we should “Buy to Hold,” paying close attention to our valuation analysis and exit positions that no longer offer a compelling value opportunity. Shen basically takes this approach by switching between an investment in the S&P 500 vs. 3 month treasuries based on a comparison of earnings yield. In short, a trading strategy based on a perception of whether the market is overvalued or not. The results were a clear victory for the timing strategies, which produced higher returns with lower volatility. Perhaps geeks bearing formulas can make the difference between retiring in Maui or in a rundown apartment complex with a roommate named Maury…
My Bottom Line
My thoughts? We’re all momentum investors, and the standard deviations in the shorter term holding periods in the Schwab study make this case very clearly. With an 20 year+ time frame, you are near certain to generate positive returns—just be prepared for a bumpy ride. If you’re temperament can’t take a 20% loss or more in your portfolio over a 3-5 year period, then you should look for risk mitigation—via asset allocation, timing, or hedging strategies. And of course, if you’re near retirement you should reduce your market exposure. Bogle’s rule of thumb that 1% of your assets should be invested in fixed income for every year old you are is a decent and conservative starting point. Just never forget that much of the market gain comes in short bursts, and if you’re overhedged in those periods, or sitting on the sidelines, then you may have put forth a maximum effort with minimal rewards (or no reward at all).
So, go for it, and join in the conversation. And keep checking in on this blog as I provide ongoing coverage on the Fool.com debate.