Buy-and-Hold Can’t Die

There’s this mistaken idea trotting around in the popular media, which usually only shows its face in bear or sideways markets: buy-and-hold investing is dead. This is wrong in several ways:

1) The average investor is horrible at market timing.  They buy high and sell low.  The more volatile the asset subclass the more pronounced this behavior is.  I have witnessed this personally while analyzing the return differences for Bill Miller, Bruce Berkowitz, and the S&P 500 Spider.  There is a profound difference between the returns that a buy-and-hold investor receives, and that which the average investor receives.  The buy-and-hold investor almost always does better; the only exception that may exist are value investors who have learned to resist price trends, painful as that may be.

2) The assets of the market are far less volatile than those that trade them.  Bonds are issued, the grand majority of them mature (pay off).  Stocks are issued, and they pay dividends, get bought out, fail, spin off another company, etc.  Trading activity usually far exceeds the need for financing assets; it becomes a game unto itself, and a zero-to-negative-sum game at that.  When you are playing a game that is overall negative-sum, i.e., the brokers suck cash out of the game proportionate to trading, the better players look for quality assets, and trade less.

3) When a sustained bull market arrives, the other mistake will show up, “Buy-and-hold is the only way to go.”  Risky assets have periods of protracted increases in valuation.  Certainty in the continuation of the process grows as it gets closer to the end of the cycle, when the cash flows of the assets cannot support the cash flows of those who borrowed to buy them.

4) Longer-term investors are often the key to a turnaround in the price of an asset.  Asset prices bottom when longer-term investors see value, and buy-and-hold, waiting out the volatility.  Asset prices crest when long-term investors decide to sell-and-wait, because the prospective returns to a buy-and-hold investor are poor.

This is why the perspective of a value investor can be valuable in approaching markets… are you willing to do a cold hard analysis of the likely cash flows?  You know that it gets harder to maintain high returns on equity [ROEs] as time goes on, and the same for low ROEs — new management arrives, and there is mean-reversion.

Conclusion

Yes, there are clever traders, but by necessity they are few in the market ecosystem, and repeatability is uncertain.  There are far more dumb traders, and repeatability is only limited by their declining capital.  Then there are the value-oriented infrequent traders.  They do best, but second to them are those that buy-and-hold.

In general, the economy rewards those who bear risk over long periods of time.  Thus buy-and-hold does well, usually, over long periods of time.  That time period may be 30-40 years, and may not do well with respect to your retirement date, so take caution, and don’t trust in long-term investing as if it is the force of gravity.  It is more akin to one who realizes the bean farming has become unpopular, and so, he decides to plant beans.  It might not work immediately, but it stands a better chance of working than those who are chasing the current farming fad.

2 Comments

  • revelo says:

    >value-oriented infrequent traders. They do best,

    Absolutely. Benjamin Graham recognized this long ago. “Buying when the overall market is attractively priced is more than half the battle won already” or something of the sort. He didn’t discuss selling when the market is unattractively priced, though that this also important–and more difficult. The key is to remember that that stock prices tend to steadily grow in nominal terms (inflation + risk-free rate + risk premium), so you only want to sell-and-wait when prices get really crazy.

  • SteveP says:

    I personally prefer to buy and hold because I did the trading thing and well let’s just say that it’s not for me. Trading caused me sleepless nights wondering what the Greeks or China might pull next to kill my plans of fortune. Buy and hold is simple and relaxing even boring at times but I sleep better and I spend less on commissions so I have more money working for me and less for the brokers pockets.

    Personally I believe it’s the commission hungry brokers who are the ones who are trying to kill the buy and hold strategy because it lends it self to less churning and thus fewer profits for them.
    Great blog you gained a reader in me.

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