Three Phony Criticisms of Buy-and-Hold

I’m a critic of Buy-and-Hold. I believe that investors MUST change their stock allocations in response to big valuation shifts to have any hope whatsoever of keeping their risk profile roughly constant. I don’t believe that is is possible that a Buy-and-Hold strategy could ever work in the long term.

That said, I believe that the Buy-and-Holders got a lot more right than they got wrong. Since the 2008 price crash it’s become fashionable to slam Buy-and-Hold for all sorts of reasons that I view as phony. It would be a terrible thing for investors to lose confidence in all of the many investing insights put forward by the Buy-and-Holders that really have stood up to scrutiny. This column will examine three criticisms that I view as unfounded and explain why I think you should hold to the Buy-and-Hold line on the points under question. [Also See: Buy-and-Hold a Defunct Equity Strategy?]

One phony (in my view!) argument that is often heard is that the crash shows that indexing doesn’t work, that investors need to learn how to pick stocks to be successful. No! No! A thousands times no!

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The Buy-and-Holders Believe in Indexing.

Investing

Because of the work I have done researching the effect of valuations on long-term returns, I have come to believe in indexing even more than most Buy-and-Holders. John Bogle revolutionized investing with his creation of the index fund in 1976. It is only in the past 36 years that it has become possible for most middle-class people to partake in the great returns generally offered by stocks in a truly simple way. I would never want to go back to pre-indexing days.

I see nothing wrong with stock picking for the small percentage of investors for which it is suited. Most of us are not in that group. For 80 percent of investors, indexing offers a way to invest in stocks that is much less risky.  Try to pick stocks without doing enough research and you are going to get killed. In the age of indexing, we no longer need to worry about investing research. Broad U.S. indexes have always provided a great long-term return.

We should rejoice that we live in a day when indexing is a viable investing option. Those who are taking advantage of the price crash to persuade average investors to return to stock picking are doing them a great disservice, in my assessment.

Short Term Timing

A second false criticism of the Buy-and-Holders is that they are wrong to disdain short-term timing. Whenever prices crash, there are people who claim that they knew what was coming and that, if you only had listened to them, you would have known when to lower your stock allocation. I am no Buy-and-Hold fanboy. Lots of Buy-and-Holders hate me for the criticism I have directed toward their favored investing strategy. I am here to tell you that it’s an exceedingly rare investor who can engage in effective short-term timing.

The research just doesn’t support the claims of those who say they know in advance where stock prices are headed. I am not 100 percent dogmatic on this point. It seems within the realm of possibility to me that there are a small number of people who really do possess this almost magical ability (I don’t personally believe this to be the case but I don’t feel that I can entirely rule out the possibility). However, even if that were the case, I cannot see how the typical investor could know in advance which expert to follow. There are always some people saying that it is a good time to buy and other people saying that it is a good time to sell!

Short-term timing (predicting where stock prices will be in six months or a year) is for losers. My Buy-and-Hold friends made a huge contribution when they came out strongly in opposition to the idea of trying to predict short-term price shifts. I think we all owe them a debt of gratitude for the (properly) relentless efforts they have put forward trying to warn us away from short-term timing.

Stocks Are Too Risky

A third criticism of Buy-and-Hold that I view as phony is the claim that stocks are just too darn risky to serve as the primary investing class of the middle-class investor. I hate this one! This one always catches on during secular bear markets. And in the long run it always causes millions to delay their financial dreams by a good number of years.

Here’s how it works. People go crazy for stocks in bull markets. They lose money that way because prices always crash once they get too high. Then they make it worse by learning the lesson that stocks can be dangerous only after prices have fallen hard. It really is bad to invest too heavily in stocks at times of high prices. But you compound the error if you then avoid stocks after they have returned to fair-value or low price levels.

Most of us are afraid of stocks. We don’t understand stock investing and we hate losing money. The behavioral finance guys and gals have done research showing that we hate losses more than we love gains. So it is an easy sell trying to persuade people to avoid stocks at the bottom of bear markets. We MUST avoid the temptation to give in to feelings of doom and gloom!

Stocks are the highest-return asset class. Most of us simply will not be able to finance a comfortable retirement without investing heavily in stocks for most of our investing lifetimes. A decision you make to avoid stocks at a time when stocks seem scary may seem prudent at the time you make it but may end up having cost you a lot of money when you someday look back to assess why you don’t have enough to retire at the age at which you had hoped to leave the daily grind behind you.

That felt good! Most of my favorite investing experts are in the Buy-and-Hold camp. I like being able to take their side every now and again!

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Comments

  1. says

    A late friend of ours was an heiress who didn’t know squat about investing… except buy and hold. She inherited a portfolio laced with blue chip stocks like Dupont and Coca-Cola, and she kept the portfolio intact for the most part until she passed away herself. She may not have killed it in the returns department, but she (unknowingly, perhaps) followed Buffett’s first law of investing: don’t lose it. She also made enough from dividends to live on, and those dividends kept growing enough through her adult lifetime that she could keep on living off of them. An extreme case of buy and hold, if ever you saw one. But one that worked very well.

    I’m not an extreme adherent to the buy and hold philosophy, but every time I hear someone slam it based on anecdotal evidence, I am reminded of other anecdotal evidence that points out that it works well. The point behind buy and hold is not to make the best return possible. The point is to make a decent return without losing it all. Sure, there will always be a lemon in the bunch and you have to prune it out of the portfolio when it goes sour. Doing so isn’t an instant condemnation of buy and hold. Buy and hold isn’t an absolute thing — it doesn’t mean you NEVER sell a stock once you buy it. It only means you don’t churn your portfolio incessantly.

    The key, though, is investing in companies which have a long term strategic competitive advantage (Buffett’s moat). If you buy stupid stocks like Facebook, buy and hold will kill you. Any strategy will. It all comes down to which companies you invest in.

  2. Rob Bennett says

    That makes all the sense in the world to my ears, William.

    Thanks for sharing your thoughts with us.

    Rob

  3. says

    Thanks for the information. The stock market world has so much information floating around and it can get confusing ; it’s nice to see some myths debunked!

  4. BrianAlt says

    Just to be clear, you recommend ETFs and Index Mutual Funds or creating a portfolio that closely matches an index?

  5. Rob Bennett says

    My thought is that it depends on the individual, Brian.

    There are a lot of people who have to invest in stocks to finance their retirements but who don’t know the first thing about creating a portfolio that matches an index. Those people (most people) should keep things as simple as possible and just buy a broad index fund.

    Some others might want to create a well-diversified portfolio that to some extent mimics an index. Why not? I see no particular harm in doing that. It might be fun putting the portfolio together, you might learn a lot through the research process and you might even get slightly better returns. So, if you have the skills and inclination to take that path, go for it?

    Some others might want to pick a certain number of high-dividend stocks that don’t even collectively mimic an index. It is only a small percentage of the population that possesses the skills to pull that off. If you have the skills, it can be a good path. Just understand starting out that, if you are fooling yourself re your skill level, you could end up paying a price. And understand that there is no need to take that path. Picking a broad index delivers plenty “good enough” returns.

    Thanks much four your question and please take care.

    Rob

  6. says

    I think holding on to stock isn’t that bad, while having a diverse portfolio helps you maintain balance sometimes you need to buy and hold when you are just starting out to build your portfolio.

  7. Rob Bennett says

    The “hold” part of Buy-and-Hold is critical, in my view, Jenna. The tricky thing about stock investing is the feedback mechanism. We all respond to feedback on our decisions. When we see good results, we do more of what we have been doing. When we see poor results, we look for other approaches. The tricky thing about stock investing is that the short-term feedback is often misleading. You take a step that will pay off big in the long term, you get poor short-term results and you abandon the strategy. That’s a disaster!

    The Buy-and-Holders have been relentless in persuading people NOT to do that, not to engage in short-term timing. It is my view that they are 100 percent right about that. I think we all owe the Buy-and-Holders a huge debt of gratitude for their efforts in that regard.

    Where I part company with the Buy-and-Holders is re the “Buy Mindlessly” part of the Buy-and-Hold equation. I don’t think people should be going with the same stock allocations when stocks are priced insanely high as they do when stocks are priced moderately or insanely low. Stocks have never once in history delivered good long-term results starting from a time when they were priced insanely high. I think we need to get the word out about the 30 years of academic research showing that to be so. It pains me to see people going with high stock allocations at times when stocks are priced to pay a negative long-term return.

    My overall view is that Buy-and-Hold was a huge advance intellectually over what came before it. Some mistakes were made. We didn’t have all the research available to us at the time Buy-and-Hold was developed. Now we just need to go back and fix the mistakes and then enjoy the better results we all will be seeing once we have the entire picture in place.

    Thanks much for taking time out of your day to share your thoughts and help us all out. It makes me happy when people ask questions or comment on my stuff. I would find investing boring if it were not for the back and forth I get to experience with people like you.

    Rob

  8. says

    Here’s a good, real life example where sticking to a long range plan of regular investing in an index fund payed out better when the market was up and down over the course of 5 years than when it went up steadily for 5 years. In this example, the market even ended up below where it had started and the investor still came out ahead.

    http://youtu.be/2pInPzeXrUM

    We all fight the urge to run when things are down and jump in when they look good. Like you described, it’s important to keep reminding ourselves of the long term view, when we’re caught up in the short term news.

  9. says

    William@dropdeadmoney makes an excellent point – the advocates of market timing, stock picking, etc – the folks that criticize buy and hole – all use anecdotal evidence to justify their views.

    And anecdotally, they could be correct. Over long periods of time, 3% of other investment strategies beat the index (though of course the index beats 97% of them). Unfortunately the same studies that show 3% can beat the index also show that the 3% is random – they just got lucky. There’s no picking that 3%.

    So you can take the strategy that outperforms 97% of the time, or you can justify another strategy that will beat the index randomly 3% and perform worse 97% of the time. Them’s the numbers, not the anecdotes.

  10. says

    I’m not a believer in buy and hold for at least some of the reasons given here. I think the key aspect of these guys is that “look at the market over time, it doesn’t stay down for long”. If you are in the market you have been right. But you could be in an individual stock and be dead wrong. I do like stocks as investment but do stick to ETFs for the bulk of my investing. They allow me to diversify across different asset classes and not worry about holding the one rotten apple of the bunch. I do a lot more short term trading/investing though. My definition of long term is when the current trend is complete, bull or bear. Sometime the trend is 6-8 months and sometimes its a couple of weeks. I catalog my thoughts on those trends and the overall condition of the market on my blog: http://everyinvestor.blogspot.com Good Luck everyone.

  11. says

    I’m not a fan of buy and hold strategy, especially for stocks (as you mentioned, that could really kill) but don’t really swear by active trading either. You can find the drawbacks here http://bit.ly/W6KIb9. I’ve set sell levels for each stock in my portfolio, and ones they hit that mark, off they go. Gold and silver billion are an exception here. I plan to sell them only in the last-resort scenario, until then would want to stack on them at the dips.

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