Buy-and-Hold: A Losing Strategy for the Future?
This isn’t the first time smart professional investors have considered abandoning the buy-and-hold strategy. Most of the controversy has surfaced following the recession. I asked whether buy-and-hold was still a good investing strategy a few years ago. Investors who had been following the buy and hold strategy — forgoing active trading in favor of buying stocks for the long term and sticking with a philosophy of patience — saw the values of their stock-heavy portfolios plummet, following the stock market at large.
This kind of catastrophe shocks investors to the core and gives people a chance to challenge their assumptions and choices. The leading argument against the buy and hold strategy for investors going forward focuses on volatility. Judging from market performance through and after the recession, stocks seem to be riskier than they have been in the past. Some investors believe that the fundamentals that made buying and holding stocks for the long term work in the past, providing an 8% average annual return over 30 year periods, have changed.
Markets are more volatile now because the bulk of investing activity isn’t done by humans making purchasing and selling decisions based on available information, most trading is accomplished by computers reacting to market changes in microseconds. Complex investing instruments like derivatives and hedge funds make it possible to take advantage of economic situations generally inaccessible via stocks.
In an interview with CNN Money, economist Andrew Low has this to say about buy-and-hold:
Buy-and-hold doesn’t work anymore. The volatility is too significant. Almost any asset can suddenly become much more risky. Buying into a mutual fund and holding it for 10 years is no longer going to deliver the same kind of expected return that we saw over the course of the last seven decades, simply because of the nature of financial markets and how complex it’s gotten.
Think about how that person earned 4%. He lost 30%, saw a big bounce-back, and so on, and the compound rate of return over the period was 4%. But most investors did not wait for the dust to settle. After the first 25% loss, they probably reduced their holdings, and only got part way back in after the market somewhat recovered.
His argument is that buy-and-hold doesn’t work because investors don’t follow the guidelines of the strategy. Carl Richards pointed out in his recent book, The Behavior Gap, that investor’s actual returns don’t match “investment returns” because people are human and react like humans. When they do react, the often do so improperly, like reacting to a high-flying stock by buying at a high price and selling when the market sinks the stock’s value. If buy-and-hold doesn’t work, it’s not a failure of the strategy, it investors’ failure to properly follow the strategy thanks to their human brains.
Do you plan to use a buy-and-hold strategy for your investments in the future, and do you expect the long-term returns in the stock market we’ve seen over the last century continue in the future?