The consequences of the buy and hold investment strategy.
During volatile periods like we have right now, the standard advice I’ve pretty much followed as a long-term investor boils down to the following points:
- Perform asset allocation.
- Diversify.
- Evaluate your portfolio and rebalance it regularly.
- Stay in the market for the “long term” or until you finally address your financial goals.
- Use index funds or ETFs.
This is basically our investment philosophy in a nutshell. But I’d like to take a closer look at a few more investment approaches I’ve tried time and again in the course of my investment “career”.
Long-Term Investing vs Short-Term Trading
In past articles, I’ve discussed the concept of day trading, and have covered long term investing vs short term trading strategies. Short-term trading hasn’t really been my investment approach of choice, although I’ve tried my hand in it in the past, and I do know many people personally who are successful at participating in this form of market play. Of course, the difference between my trader friends and me is that they actively follow the markets and their investments on a daily basis, while I leave my investments in auto-pilot for the most part. I’m just unable to commit an inordinate amount of time to my investment portfolio as I’m busy enough as it is.
For a passive investor like me who subscribes to long-term investing and indexing, and who limits market timing to a small portion of my portfolio, this may indicate that I’m pretty much one who buys and holds. But in reality, I also don’t believe entirely in the concept of “buy and hold”. I don’t think that buying and holding should be considered synonymous to long-term investing because it insinuates that your strategy compels you to stay put in a particular investment forever (no matter what). Instead, I’d buy and hold according to the parameters specified by my specific asset allocation and long term investing goals.
The Buy and Hold Strategy
Buy and hold is the antithesis of day trading. However, either strategy can be problematic if applied unchecked. With day trading, we can’t help but keep our eyes obsessively on the markets, while with buy and hold, we neglect our positions and may not be checking our portfolios often enough. Buy and hold seems to have worked well if you were in US equities over the span of a lengthy bull market:
My Oracle Stock Story
I still recall the story of a friend of mine and former co-worker who, along with me, owned shares of Oracle stock in our ESPP plans. We roughly had the same amount of shares in our accounts. The difference though was this: I sold my shares early while my friend held on to hers, even quitting her job to go on an around-the-world trek for an entire year; a trip that was fully subsidized by occasional sales of her stock.
The irony here was that she came back to even more money than she started with (despite not working for a year), thanks to a strong market and a buy and hold strategy. I, however, was still toiling away at my job after that same year — with not much growth in my investment balance — having given up the ride on Oracle too early.
Yeah, this sure is a fantastic strategy if the long term trend is up, which is what everyone expects. U.S. bull markets have been kind to investors, but now that we’re in bear market territory, it’s a whole ‘nother story. In the case of a prolonged slump, what you’re buying and holding is “dead money”.
Evaluating Your Long Term Investment Horizon
Take for instance the situation we have today: if you’re close to retirement — even 10 years is fairly close(?) — then getting caught in a long-term market slump like what we’ve seen with Japan, or something like what we’re experiencing right now in our very own U.S. stock market could throw a monkey wrench in your retirement plans.
The problem here is not that long term investing has failed us, but that it’s been misapplied. As investors, maybe we’ve become too inflexible about our portfolios and have forgotten about the risks, having been spoiled with awesome returns throughout the boom years. Without practicing appropriate asset allocation (where you dial back the risk over time based on various factors) and misinterpreting what “long term” means, an investor becomes vulnerable to potential losses. In my opinion, it’s all a matter of semantics, and perhaps we’ve simply forgotten that long term is not 5 years or 10 years — it’s 25 years or longer (thanks to Wealth…Uncomplicated for this reminder!).
I believe long term investing is still the way to go, but we’ve got to be careful about defining what this means. You’ve got at least 25 years still left? Then embrace the market and the opportunities it presents today.
Copyright © 2009 The Digerati Life. All Rights Reserved.
{ 16 comments… read them below or add one }
You don’t have enough time to invest in stocks for the purposes of paying college. The risks at this point are too high. If there is a market swing, and there are plenty these days, you will be wiped out. Need shorter time, more secure investments. And, they will not yield too much, but are safer.
I agree with your point that “long-term” has been applied too liberally. Each investor should assess their own investment horizon and allocate their portfolio accordingly. Too many people have come to financial ruins by mismatching their cash flows. I have a guest post coming out at Jeremy’s Gen X Finance next week that will also talk about this. Great post, long term is not always synonymous to buy and hold!
What’s interesting to think about is how even buy-and-hold is pretty frenetic compared to other economic activities: people rarely change careers more than once or twice in a lifetime, and don’t change homes very often, either, but see nothing contradictory about having a portfolio that is 20% insurance companies one year, and 20% router manufacturers the next.
Some of this is because the transaction costs are lower for stocks — but if you trade a lot, they really add up.
Slow and Steady wins the race. That has become my financial motto. And I intend to take it slow and steady.
-Nate
Part of me is glad the market fell, it lets me buy a little more, and part of me is sad because I know a lot of near retirees were hammered because they made some poor allocation decisions. It’s bringing the idea of asset allocation back into play, which is good, but a little too late for some. Unfortunately, this stock market fall is coupled with a broader recession (unlike the dot com boom) so it’s harder for near retirees to find jobs to cope.
Too much media junk touting buy and hold is dead, but if we keep buying some good companies at todays prices, we’ll prove whether it is dead or not.
Regular readers of my stuff know that I have been trying for some time (eight years!) to diminish the level of dogmatism that some feel over Buy-and-Hold so that we can open up investing discussions to lots of exciting ideas that conflict with the Buy-and-Hold model. My thought for this year is to go to the political blogosphere and to try to gain supporters there with an argument that it was the continued promotion of Buy-and-Hold for 30 years after the academic research was published showing that valuations affect long-term returns that caused the economic crisis (we have made ourselves so poor with this investing “strategy” that we can no longer afford to buy stuff!). The economic crisis has obviously affected the political debate (many middle–class workers are alarmed that our economic and political leaders have been so ineffective in their handling of the crisis).
If this works, I think it could be a big deal. I believe that we all place too much emphasis on “expertise” in the investing area. Anyone with common sense can come to understand investing just fine if they don’t buy into all of the crazy marketing slogans put forward by The Stock-Selling Industry. My experience is that the primary expertise of most of those whom we think of as “experts” in this field is in selling stuff. If we can get more people involved who come at these questions from a common-sense perspective rather than with a defensive unwillingness to acknowledge that perhaps they have actually gotten some things wrong from time to time, we will change the history of investing.
There’s tons to learn if only we can open ourselves to it and find ways to talk to each other about what we have learned. Perhaps we will make some friends in the political blogosphere who will help us find an end run around those who don’t like the idea of questions being raised about popular (but long discredited by the academic research) investing strategies.
Rob
Appreciate the info Rob — I realize you are very passionate about your work goals especially in the realm of investment theory.
Rob Bennett seems to enjoy complaining about how someone else’s dinner tastes, for them: “…it was the continued promotion of Buy-and-Hold… that caused the economic crisis … we have made ourselves so poor with this investing “strategy” that we can no longer afford to buy stuff!”
Rob,
Contrary to your claims, Buy and Hold allowed me to retire early, to a place I love, with a feeling of peace and security and abundance. I realize that you for some reason have decided to turn your antipathy for this actually sort of uncommon mode of investing into something resembling a religious war, but can you please stop to respect both:
* Truth; in the accuracy of what you say,
* Other people’s points of view; in that they may have different points of view?
I’d thank you to do that.
Other people’s points of view; in that they may have different points of view?
There are millions of good and smart people who believe in Buy-and-Hold with their hearts, minds and souls, NoFalse. I feel a great deal of respect and affection for these people. John Bogle is a hero of mine. I think it’s fair to say that he believes in Buy-and-Hold, no? Bogle is also the godfather of Valuation-Informed Indexing, the investing strategy that I explore at my site. I couldn’t do the work I do in the investing area were it not for the many wonderful things I have learned from John Bogle.
You really are putting your finger on something of importance here, however. You say that I should respect the “viewpoint”of Bogle and the other Buy-and-Hold advocates. I respect the people who came up with these ideas because they are good and smart people who have helped us all in many important ways. I do not respect the Buy-and-Hold idea. I hate the Buy-and-Hold idea. Asking me to respect the Buy-and-Hold idea is like asking me to respect racism or sexism or communism or war or ignorance or poverty. Not this boy.
I love the people. I hate the idea. Do you see the difference?
I hate the idea because I love the people. Buy-and-Hold says that there is no need to take price into consideration when buying stocks. This is Get Rich Quick investing. This hurts people. It causes failed retirements. It causes failed businesses. It causes failed marriages. What’s not to hate?
People came to believe in Buy-and-Hold because of a mistake (the mistake goes by the name “Efficient Market Hypothesis”) made by the academics who developed the model. The reason why the academics made the mistake is that they are humans. All humans make mistakes. Fortunately, humans also possess the ability to correct their mistakes. Academics who came later did research revealing the mistake. That research was done in 1981 (and confirmed many times since). Had the Buy-and-Hold advocates simply acknowledged the mistake when it came to their attention, we would not all be enduring an economic crisis today.
The trouble comes from the fact that the model that has caused such financial ruin brought in hundreds of millions of dollars to The Stock Selling Industry. There is a feeling of great shame today about what has been done to us as a result of this mistake and the unwillingness of those responsible for it to correct it for so many years. Here’s the question that all of us who care about these people need to be thinking about — Is it better for them for us to point out the mistake and get it corrected or is it better for them for us to let the mistake continue destroying the U.S. economic and political systems? I obviously think it is better for every single person involved to get this mistake corrected as quickly as possible.
Is your best friend the person who lies to you when you are doing things to destroy your career and your marriage and your health? Or is your best friend the person who takes you aside and tells you (in kind but blunt works) that you are messing up and that you had better get your act together? I say things bluntly because I have learned from experience that that is the only thing that has any hope whatsoever of helping my many Buy-and-Hold friends find their way to a better place.
Buy-and-Hold is a data-based model. Those of us who follow the literature have known for 30 years that those who developed this model got all the numbers wrong. All of the conventional investing wisdom of the past 30 years is the opposite of what works, according to the entire historical record. The Stock Selling Industry has just about zero interest in getting the word out. But personal finance blogs are not owned by The Stock Selling Industry. We have the power to get the word out and to thereby keep the U.S. economy from falling into the Second Great Depression. I see that as work worth doing, NoFalse.
And you know what? I think there are thousands in The Stock Selling Industry who would breathe a huge sigh of relief if we succeeded in this work. These people want to give good advice. John Bogle did not start out as a little boy dreaming of the day when he could bring the U.S. economy to its knees by telling middle-class investors to do the opposite of what works with their retirement money. John Bogle deep in his heart wants this matter cleared up (even if he is not able to acknowledge this today).
I respect all Buy-and-Holders, NoFalse. I respect them enough to know that deep in their hearts they want to invest effectively and they want all of their friends and neighbors and fellow community members to invest effectively. We are all in this together. We all have a part to play. I’ve been given the job of being the one to let the cat out of the bag and launch a national debate on what really works in stock investing. I am going to give it my best shot. I will fight it hard.I will fight it to win. If I remain true to myself, I will also fight it with love in my heart for all Buy-and-Holders every step of the way.
I am not your enemy, NoFalse. I am your friend.
Rob
After much snipping and pruning, we get to Rob claiming: “Buy-and-Hold says that there is no need to take price into consideration when buying stocks. This is Get Rich Quick investing.”
Rob, your assertion makes no sense on it’s face. And seeing you repeat it many times doesn’t somehow add more sense than was initially there.
Implicit in the term “Buy and hold” itself is the expectation that it will take TIME — this is the “hold” part. So, one may have to “hold” while the market goes up, and goes down, and goes sidewise. But you hope to be in it LONG ENOUGH (again, that’s the ‘hold’ part) to gain on the average expectation of the market. No one is ramming that vision down people’s throats. It is certainly not the most common practice. And even those who like the idea in principle often lack the discipline to execute it for real. So two things become readily apparent about your assertion:
1) Buy and Hold is not a ‘get rich quick’ scheme. First, it’s not even about getting ‘rich’ it’s about capturing the net average gains. This is the mature opposite of stock speculators and timers. But most important of all, there is nothing “quick” about it; either in promise or in practice. Again, the “hold” is right in the description.
2) Since the practice of Buy and Hold is difficult, it is not particularly popular, and is surely NOT endorsed by industry which likes selling different stocks, many times, it certainly is not accountable for all the evils you lay at it’s door — the housing market crumbling, the recent stock swoon, etc.
In my opinion, your position is not a very good basis on which to found a ‘movement,’ especially one that cannot stand even the most rudimentary logical inspection.
Good luck to you, but if you don’t change your tune, I doubt you will find many dancers.
Implicit in the term “Buy and hold” itself is the expectation that it will take TIME — this is the “hold” part. So, one may have to “hold” while the market goes up, and goes down, and goes sidewise. But you hope to be in it LONG ENOUGH (again, that’s the ‘hold’ part) to gain on the average expectation of the market. No one is ramming that vision down people’s throats.
The part that we disagree on is the “No one is ramming that vision down people’s throats” part, NoFalse.
There is a trivial sense in which the rest of what you are saying here is “true.” I put the word “true” in quotes because what you are saying is more false than true (in my assessment!). But there is indeed at least a surface sense in which it is true. The problem is that your claims are half-truths and the part that is false is far more dangerous than the part that is true is helpful.
Those who bought stocks during the time when they were insanely overpriced (the time-period from January 1996 through September 2008) will indeed end up ahead if they hold those stocks long enough. The problem is that the length of time that they are going to need to hold is not the length of time that they have been led to believe they are going to need to hold by the marketing campaigns of The Stock Selling Industry. Most middle-class investors interpret the claim that stocks always do well in “the long run” as an assurance that they will end up okay if they are able to hold at least five or ten years. Nothing could be further from the truth. The historical data shows that it may take as long as 50 years for people who bought stocks at insane prices to end up doing better than they could have done buying Treasury Inflation-Protecting Securities (an asset class that comes with a government guaranty attached).
Buy-and-Hold has become popular four times in U.S. history. It caused a devastating economic crisis on each of these occasions (since 1900, we have never suffered an economic crisis that was not preceded by a time of widespread praise for this investing “strategy”). Assuming that we see losses this time somewhat in accord with what those of us who have looked at the historical record have come to expect, those middle-class investors who bought into the Buy-and-Hold mumbo jumbo will be seeing losses to their portfolio amounts of something between 80 percent and 90 percent real. What percentage of those people will end up holding 50 years?
The obvious answer is — a number closely approaching zero. Stock values dropped 80 percent in the years following the 1929 crash (we went to far higher valuation levels in the 1990s). It is entirely possible that not one middle-class investor held through those losses. Yet the Buy-and-Hold advocates point to those years as years in which Buy-and-Hold “worked.” It worked? Even though every single person who bought into the marketing campaign for this “strategy” suffered devastating losses? Even though not one of those following it held in the real world? I say “no.” I say this is gibberish.
What works for me is a strategy that helps real live people living in the real live world. Buy-and-Hold works on paper, that’s all. It’s not the same thing. It’s not even close.
Investing for the long term is a wonderful idea. On that I am in 100 percent agreement with the Buy-and-Holders. What I say is that middle-class investors should aim to keep their risk profiles roughly constant. If the risk of holding stocks is low (there is minimal risk at times of moderate and low prices, according to the entire historical record), middle-class investors should be heavily invested in stocks because of the great return they provide. When the risk of owning stocks is off the charts, I think that middle-class people should be cutting back on their stock allocations so that they have a reasonable chance of holding onto those stocks that they do own. At the prices that applied from 1996 through 2008, this means going with a stock allocation of something in the neighborhood of 20 percent, certainly no more than 30 percent except for those in exceptional circumstances.
Buy-and-Hold “works’” in the marketing materials generated by The Stock Selling Industry. That’s because they just happen to “forget” to include consideration of the factors that always make it such a real-world disaster for those who elect to follow it. And, yes, the marketing materials are indeed rammed down people’s throats. Honest posting on the flaws of the Buy-and-Hold Model is today banned at the Motley Fool site, at the Morningstar.com site, at IndexUniverse.com, at Bogleheads.org and at a number of personal finance blogs. Why? Why are the thousands and thousands of middle-class investors who come to these places to hear the straight story of what works in stock investing only permitted to hear one side of the story, the side that just happens to be the one that brings hundreds of millions into The Stock Selling Industry (every industry obviously wants its customer to believe that its product is worth buying at any price imaginable — I know of no other industry that gets away with promotion of such an obviously preposterous claim)? Forgive me if I have come to believe that the huge financial incentives for telling middle-class investors precisely the opposite of what works might be partly to blame for our current economic crisis, NoFalse.
I doubt you will find many dancers.
I invite you to take a look at the “People Are Talking” section on the left-hand side of the home page of my “A Rich Life” blog, NoFalse. I have already found a good number of “dancers,” both among the ranks of experts and among the ranks of ordinary people seeking an investing strategy that stands a realistic chance of working in the real world. The millions of people whose financial futures are being destroyed by the reckless promotion of Buy-and-Hold for 30 years after the academic research showed that its chances of working in the real world are precisely zero are the people who built our economic and political system. I have a funny feeling that some of them may be in the process of developing a desire to take it back. We’ll see.
Rob
Geez….
Rob has such a contorted view of investing and people that it’s difficult to know where to start. Oh, why bother.
I know people want to debate and Rob tends to be a strong “debate magnet”. I would, however, refrain from taking the arguments personally. My take on things is that there’s room for all financial strategies and do whatever works for you. I don’t think there’s a wrong or right way to approach things — but I also believe in everything in moderation. Sometimes a strategy works well, sometimes it doesn’t, depending on circumstances. Buy and hold works well in up markets, and it sucks in more volatile, flat markets. So how do I go about things? I do a mix of approaches and diversify. It’s worked for me.
And this year? I’ll be doing more of the same. Going with the flow and being flexible about how you approach your plans and strategies can serve you well.
“your claims are half-truths”
Amazing.
This is why every attempt to engage Mr. Bennett ends in failure — he simply cannot accept any information that is contrary to his already chosen position that there is some evil afoot, so anyone who points out his mistaken assumptions and/or erroneous thinking is immediately slandered as a liar and/or a ‘hater.’
Good luck with your planned assault on the political blogosphere. I suppose it’s true that some sort of change is in order, since you have failed to convince the financial blog community, but as is often the case with you, I’m not at all convinced that you are applying sound reasoning in assuming that the frothy mix of politics is the right place to take your war on passive index investing; which is about the most benign thing a person could do, and one that I am not sure can be outlawed without significant impact on our basic personal freedoms! I mean, will your plan criminalize the decision to *NOT* trade regularly (chuckle)?
Here is a truth, and no half-way about it: you will certainly be no more successful convincing that population of the correctness of your arguments than you have with this audience.
Anyone who points out his mistaken assumptions and/or erroneous thinking is immediately slandered as a liar and/or a ‘hater.’
This response is emotional, NoFalse.
This is one of the big problems with the Buy-and-Hold model. It encourages emotionalism in investing. I think we should be taking it the other way. We should be discouraging excessive emotionalism.
Middle-class people buy thousands of things every year. We buy cars and sweaters and cell phones and videos and bananas. And there is one common theme in every purchase we make — price always matters. If the people trying to sell us sweaters or bananas tried to get away with telling us that their products are a good deal at any price, we would laugh at them. Rightly so.
I think we should do the same when The Stock Selling Industry tries to tell us that stocks always provide a good long-term value proposition regardless of price. This claim is self-serving and unbelievable. And the entire historical stock record shows that Buy-and-Hold is the worst strategy possible for the long-term investor. The incredible think is not that there are now more and more people becoming skeptical of the conventional investing “wisdom” but that The Stock Selling Industry got away with this one for so long.
We middle-class investors bear primary responsibility for that one, I fear. All humans are weak. We all possess a Get Rich Quick impulse. We all would like to believe that there’s some alternative universe where eating six pieces of chocolate cake each day is good for our health and where failing to adjust our stock allocations in response to dramatic changes in valuations might not cripple our retirement accounts. I think that, if we are to hope for our financial planning efforts to bear good long-term fruits, we are going to need to work harder to disabuse ourselves of such fantasies.
I would not listen to a doctor who told me that it’s fine to be 100 pounds overweight just because he knew that that was what I wanted to hear from him. I understand that his flattery is going to cost me in the end. It’s the same with investing advice. I don’t want the “experts” telling me what I want to hear when I am dangerously overinvested in stocks. I want them telling me what really works.
I wish you well with your investing efforts, NoFalse. But I cannot say that I have confidence that you are on the right track.
Rob