Buy and Hold as a Stock Market Strategy

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I’ve read several articles recently that claim that buy and hold as a strategy is dead. My contrarian nature makes me believe that this may be the best time for a buy and hold strategy – if for no other reason than the fact that it is getting so much grief at the moment.  Additionally, most of the data cited looks at the performance of the S&P 500 over the course of the last 10 to 15 years.  This is not the way most people invest. Most investors actually invest in several different asset classes that have different performance over time.  They should re-balance regularly, but most data indicates that they don’t.

During the current bear market, most asset classes have all declined.  As a result, it’s difficult to find anything positive in the investing world today, so what is an investor to do?  In this post, I’ll look at some of the alternatives to see if they are viable to the individual investor.

Buy and Hold as a Stock Market Strategy

Cash: Sell in May and go away, right?  Anyone who sold everything and converted to cash before mid-last year is looking pretty smart right now.  But how about if you sold in November when the S&P was at 750?  Or March, when it was even lower at 675?  You probably wouldn’t feel quite so smug.  The problem with getting out of the market is when do you get back in?  The alternative is trying to build wealth using only cash like accounts (CDs, Money Markets, etc.).  Unless you plan on saving a LOT of money, this probably isn’t very viable.  Warren Buffet wrote a wonderful Op-Ed piece in the New York Times titled, “Buy America. I am.”  In it he describes the risks of cash as an investment vehicle.

“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

Bond Ladder

Slightly further up the risk (and return scale) is the concept of a bond ladder.  Instead of investing in a bond fund or ETF – which can change in value daily, you hold your money in a series of bonds with staggered maturities from say 1 to 10 years.  When a bond comes due, you the proceeds are invested into new bonds (plus the interest earned from other bonds in your portfolio).  In theory, you have a guaranteed return considering you hold your bonds to maturity.  Although your bonds will still fluctuate in price, you can be somewhat sure that you will receive your yield to maturity.  I say “somewhat” on purpose – as this crisis has taught us: nothing is guaranteed.  Some of your bonds may be called early – an inconvenience to be sure but this shouldn’t represent a loss of principal.  However, over a long stretch (and for most people they will be investing for a longgggg stretch) you will undoubtedly experience some defaults.  Currently Chrysler bond holders are scheduled to receive 29 cents per dollar of face value on their bonds.

Active Money Management:

You can either do it yourself or hire someone to do it for you.  There are literally thousands of different strategies for making money in the markets and you can find lots of people who will take your money and invest it for you.  To do this effectively, you need to pick a good manager, be comfortable with their investment style (as opposed to all other styles out there) and constantly stay on top of their performance.  The problems with this approach are many (Bernie Madoff springs to mind).  But for individual investors I’ll highlight what I think is the biggest issue:  No investment strategy performs well all of the time.  If you utilize a private money manager, there are times when that strategy will not perform well and you will need to have a lot of trust in the manager and the strategy to avoid pulling out at the wrong time.  Imagine under performance against one of the popular indexes for a period of time and how that might shake your confidence in the investment strategy being pursued (hmmm… is this what’s happening to buy and hold…)

Hedge Fund or Investment Partnerships:

These have all the potential disadvantages of active money management – plus.  For starters: 2 and 20.  Normal fees have been 2% of assets under management plus 20% of profits.  This is likely to change in future due to the recent performance of hedge funds in the current down market.  Also, investors need to be categorized as “accredited investors” meaning at least $1 million in net worth or a high annual income.  This eliminates, oh, 95% of the population.

For an individual investor (assuming you are not an investing geek like Bootstrap) none of these options seem to have serious appeal.  They either have low expected returns (cash) or require significant time and research (and a high geek-quotient).  I suspect for most investors an asset allocation account is a much better choice.  I’ll discuss more in a future post.  In the meantime, let me know what you think of the current buy-and-hold-bashing atmosphere.

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