Is Buy and Hold Not Working? Part 1

Recently, my son-in-law got a cold call from a stockbroker. “Jim,” the stockbroker exclaimed, “Buy and hold isn’t working!” James, intelligent man that he is, begged off with the response that his father-in-law is a financial advisor and that he was “all set.”

While I certainly appreciate my son-in-law’s loyalty, the stockbroker’s statement had me thinking. If you had been the recipient of that cold call, how would you have responded to the statement: “Buy and hold isn’t working any more.” My suggestion is that you ask, “Compared to what?”

Well, I suppose one answer would be compared to a strategy which keeps you out of the stock market when it’s going down. Unfortunately, no such strategy exists. If it did, pension funds with billions of dollars would be using high priced managers to implement it.

An October article in Fortune magazine, Is Buy-And-Hold Dead and Gone? had these useful observations on this issue.

You can’t time the market.

The evidence shows that most investors get it wrong over and over again. According to a study called the Quantitative Analysis of Investor Behavior by financial research firm Dalbar, over 20 years through the end of 2007, the average equity-fund investor earned an annualized return of just 4.5%, vs. the S&P 500’s 11.8% return. Why? In large part because investors, chasing performance, shift money out of lagging funds and into hot ones at the wrong times. We buy high and sell low repeatedly.

Need more evidence? Go back to the dot-com bubble. In the first quarter of 2000, according to Morningstar, investors channeled $97 billion into equity funds – nearly double the total of the previous two quarters – right before the S&P 500 peaked on March 24, 2000. And in the third quarter of 2002, they withdrew $41 billion from stock funds just before the market bottom on Oct. 9.

(Emphasis added.)

Conclusion

No one can accurately or consistently predict the short term direction of the stock market, but selling stocks, or refusing to buy them now, because they have gone down in price, is not likely to be a winning long-term strategy. Historically, stock markets have had sharp increases following a bear market. The difficulty is identifying when that move is for real. Bear market rallies, bear traps, etc. tend to keep investors gun-shy, so a sustainable bull market rally will only be identifiable in hindsight.

Nevertheless, individuals who keep their investments in cash or Money Market funds will miss out on most of the move.

To be continued.