The Life and Subsequent Death Of Buy and Hold Investing
The Life and Subsequent Death of Buy and Hold Investing
Current market fluctuations over the past two years have bred new life into the age-old theory of whether or not it is better to buy and hold investments over the long-term making incremental investments over time or rather attempt to time the market or trade your way to profits. This thread is not my own personal idea but another branch off of Tom Gardner’s thread which discusses the merits of buy and hold investing and what it takes to truly become a long-term investor. That article can be found here: http://www.fool.com/investing/general/2009/06/05/long-term-investing-doesnt-work.aspx
I don’t think you can truly appreciate how effectively buy and hold investing worked until you thoroughly examine its past and look at the multiple events, technologies and tools which enabled the individual investor to become more involved with Wall Street trading.
Since the early 1900s and through the mid to late 1990s Wall Street was essentially run by financial institutions. The majority of the investing public followed what they could through nightly news programs on television, although the business section of their local newspaper was generally the medium by which information was disseminated. Most of those investors were far too small to go it alone and the mutual fund scene dominated the landscape. Costs associated with buying and selling stock were high, volumes were relatively low based on what we see these days, and access to information as we just stated was difficult at times.
Although there had been corrections in the past, including the October Crash of 1987, the stock market had always proven resilient, and investors are always, if anything, willing to believe in the historical happenings of the stock market. Every bear market prior to this mid to late 1990s period had been met by a voracious recovery within a decade and as we’ve seen from fellow FOOLers on this site, many graphs show that the long-term value of buying and holding does indeed create steady profits.
But a major shift has occurred over the past 10-15 years that has changed the investing landscape and skewed it irreparably toward traders and away from long-term investors. Unfortunately, as I see it, there isn’t a simple one-part answer to this question as to how this occurred. I have come up with numerous factors that I believe played off of each other to create the momentum-oriented environment that you see before you today.
I think first and foremost what needs to be said is that the access to information is more viable now than ever. It’s not that we didn’t have access to company info in the 1980s, but access was not nearly as quick and instantaneous as it is now. The Internet has revolutionized the way we can evaluate a stock and place a trade. Recently, accounting scandals and poor business practices have caused an even greater shift toward investor independency. Individual investors simply can’t or won’t trust the research they receive from Wall Street institutions as much as they used to. They have a government so dedicated to increasing the transparency of Wall Street that they figure any research can be done on their own.
Pairing hand-in-hand with the ability to get company information at the click of a mouse is a general trend of Internet and financial institutions of decreasing trading costs. If you take a general trend of a round-trip stock trade back in 1999 and look at the average cost of a trade today you’d see that costs have nearly been halved, and not surprisingly the amount of trades made by individual investors has risen. What is even more incredible is just how drastically institutions have increased their trading and share turnover over the past decade, the reason(s) of which I will get onto later.
The nature of stock trades is also of interest. Prior to the mid-to-late 1990s the majority of trades were executed by brokerage houses and large financial firms in moderately sized blocks. With the individual investor getting more involved in the game over the last decade we have seen the average order size decrease dramatically. Frequently we see orders run through for just hundreds of shares which is yet another way that turnover can increase and volatility can rise.
One single factor that I think bears a huge responsibility for changing the nature of buy and hold investing and could be the “one” factor that attributed the most to its death is the reduction in the tick rules. Beginning in 1997, in order to increase trading and reduce the spread between the bid and ask, the minimum tick was reduced from 1/8th of a dollar to 1/16th of a dollar. Also in 2001, they took it a step further and eliminated the fractions altogether, going with the decimal system that is still in place today. These actions set the stage for the demise of the buy and hold investor! Since the tick reductions we have seen smaller spreads, higher volatility, increase share turnover, and more investor independency.
Other tools have added to the independence of the individual investor. Within the past couple of years we have seen the emergence of ETF’s- electronically traded funds. These funds take a basket of stocks, put them together and they trade like a tracking index. Prior to the past decade, there really wasn’t an effective way to buy into anything more than a single company at a time unless you knew how to play the commodities market, which very few people did back then (and still don’t now for that matter!). ETF’s have opened up a vast amount of possibilities for traders and institutions alike and we’ve seen an explosion in the amount of ETF baskets available. If you were to compare the performance of standard index funds versus most ETF basket funds, you would see that ETF’s have, in their short history, vastly outperformed the index funds.
Likewise, all you have to do is look at the Internet and a more educated investor/trader to understand why we have seen such a dramatic rise in options activity. As the individual trader has become savvier, he/she is able to do more with less. He/She is becoming more willing to take short-term risks in the options market, which in turn is increasing the underlying volatility in the overall stock market.
Volatility has a strange effect on the human psyche. It seems to be the one thing that can break the notion that history can repeat itself. We know that long-term investing has worked in the past, but we’ve been burned all too recently by the Nasdaq Crash of 2000-2001 and the financial crisis of 2008-2009 to factor that in. We have had the phrase “past returns are no guarantee of future results” burned into our minds for 11 years now. Stock market volatility and financial rhetoric dictates that our best route of survival is to approach the stock market with a 10-foot stick and jab at it now and then just to see if it still responds.
This market correction (or implosion) has also taught us a very valuable lesson about investing- we are not alone! In 1997 the world was still very much partitioned into trade regions and the US remained a dominant financial force. When Japan suffered a near financial collapse in 1997 our markets did react, but very quickly recovered while Japan languished for nearly a decade afterwards. Twelve years later we’ve seen world trade jump up dramatically and I’m not sure whether this is a good or a bad thing, but we’ve also seen a globalization of world stock markets. I’m not saying that a 10% drop in the Turkish stock index is going to collapse our financial system, but we are more tied into the success of the rest of the world than ever and unfortunately its going to be a very long time before most of those countries are firing on all cylinders again. Just as we like to look upon our 100 year old history which dictates that buy and hold strategies work, foreign markets like Japan make us think otherwise (65%+ negative return over the last 20 years with a buy and hold strategy).
I think the final nail in the coffin to long-term investing was the rise and subsequent fall of the Baby Boomers. Children are very impressionable and will tend to follow in the footsteps of their parents when it comes to investing. Baby Boomers were expected to be relied upon to sustain our economy for at least the next 15 years given that they had built up their savings during the practically uninterrupted bull market run from 1992 to 2007. The majority of Boomers are long-term investors with a mix of individual investors and institutional customers but nearly all have lost 35-60% across the board. With staggering losses like that most of these Boomers have no choice but to actively and aggressively get back to trading. Frankly, this generation doesn’t have a 20 year horizon to work with and tell me, just what do you think the Boomers’ children will take away from this experience? My guess would be that staying on top of your investments is paramount and sitting idly by is a poor financial decision.
The sting of short-term memory, the Baby Boomers financial decisions, trade regulations, the invention of the Internet and the subsequent reduction of trading costs, increased options volatility, the addition of ETF’s and a more globalized world have all contributed to the decade-long demise of long-term investing. They say certain genetic traits skip a generation, so perhaps after 20 years and the sting of this financial crisis are gone, maybe we’ll see an environment conducive to buy and hold investing, but as of right now, there is no clear evidence or indication that people have the fortitude or trust to buy and hold anything for a decade or two. It was nice knowing you long-term investors, now clear a path for the momentum and swing traders.