Can We At Least Be Honest?
Yesterday I was reading an article entitled Don't Believe in Buy and Hold, but what I wound up not believing was what I was actually reading.
To be sure, anyone who's been around the financial press lately has probably read one or two pieces like this declaring that 'buy and hold' is dead. Certainly for buy and hold investors such as myself, the current bear market has been rather painful -- and I've heard many stories of people capitulating, throwing in the towel, and eschewing stocks all together.
While I remain strongly convinced that buy and hold is the general strategy that works best for me, I'm willing to admit that it might not necessarily be the best strategy for everyone (though I'd contend it likely is for the majority of us who invest in stocks). If we're going to criticize buy and hold, though, can we at least do it honestly?
Here are a few excerpts from the article, along with why I think the arguments made against buy and hold are, at the very least, woefully misguided.
The buy and hold devotees say you can't time the market, and if you aren't in all the time, you risk missing much of the gain. A Spanish research firm found that if you removed the 10 best days for the Dow Jones industrial average in the 1900-2008 years, two-thirds of the cumulative gains were lost. But if you missed the 10 worst days, it found, the actual gain on the Dow tripled. These results are in line with our earlier research and reflect the fact that stocks fall a lot faster than they rise.
While removing the 10 worst days may indeed have a greater impact than missing the 10 best ones, the author is assuming that the average investor has the power to do either one. If one can't time the market, one can't time the market. If you can, a tip of the ol' jester cap to you, if you're like me and can't, well, all of the evidence presented about the worst days compared to the best days becomes meaningless as our ability to avoid the worst days is no better than our ability to participate in the best ones.
We eschew the buy and hold strategy because of what's known in classical statistics as the gambler's ruin paradox. The odds may be in your favor in the long run--in this case, your stocks may provide great returns over, say, 10 years. But if you hit a streak of bad luck, your capital may be exhausted before that long run arrives.
First, the idea of the Gambler's Ruin when applied to positive expectation games (which is what investing in stocks must be, or else there's no reason to invest at all, be it buy and hold or any other strategy) only applies when, "a gambler who raises his bet to a fixed fraction of bankroll when he wins, but does not reduce it when he loses, will eventually go broke, even if he has a positive expected value on each bet."
That's a pretty narrow set of statistical circumstances. Not only that, any investor who uses the above strategy is not engaging in buy and hold in the first place. The above gambler is constantly varying the size of his or her 'bet' based on whether he or she won or lost the last one. Such a 'gambler' in the stock market would be constantly moving money in and out of the market (placing different sized 'bets'). Not only does this narrow statistical example not apply, the principal behind it misses the mark by an equally wide margin.
The argument seems to be that with 'buy and hold' one runs the risk of a streak of luck so bad (a bear market so severe) that one's capital is completely wiped-out. First, I've never seen the stock market as a whole, as measured by any broad-based index, worth zero. So the idea of the gambler's ruin certainly does not apply. Furthermore, part of buy and hold as I understand it is to continue to add new money to one's nest egg on a regular basis -- something which, again, renders the above gambler's ruin argument completely moot.
Or more likely, a severe bear market will scare you out at the bottom.
I bolded that one because it's probably the worst of the lot. Buy and hold doesn't work becuase people won't follow the strategy and hold? Delcaring a strategy broken because people might not follow it does not invalidate the strategy.
Our all-time favorite graph shows the results from investing $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and rolling it into another 25-year Treasury annually to maintain that 25-year maturity. On March 31, 2009, that $100 was worth $16,656 with a compound annual return of 20.4%. In contrast, $100 invested in the S&P 500 at its low in July 1982 was worth $1,502 last month for a 10.7% annual return including dividend reinvestment. So Treasuries outperformed stocks by 11.1 times!
This is blatant cherry-picking. If one invested in Treasuries when yields were at their peak in 1981 one will have outperformed stocks if one were to declare the 'race' over in the middle of one of the worst bear markets any of us have likely seen in our lifetimes? Sure, Treasuries may have clobbered stocks in this narrow example (which seems designed to choose the starting and ending points that would precisely give Treasuries the biggest 'leg up' possible), but nobody ever said stocks will always outperform Treasuries over every time horizon. A more honest comparison might be to compare the 20 year results of portfolios started on January 1st of each year beginning in, for example, 1950 (or any other date you want so long as we have a decent number of 'races' to compare). Sure, Treasuries might have won a couple of those races, but without knowing the exact results I'd be willing to place a very big bet that stocks would have won the vast majority of them.
Yes, bear markets are no fun for buy and hold investors like myself -- and perhaps buy and hold isn't for everyone -- but if we're going to declare the strategy dead, or argue that people should not believe in it, at least we should do it honestly.
Russell (a.k.a. TMFEldrehad)