The Aleph Blog » Blog Archive » Buy-and-Hold Can’t Die, Redux

Buy-and-Hold Can’t Die, Redux

When I wrote my piece last night, I did not write it to say one ought to buy and never sell.  In investing, I encourage the concept that one must look to relative valuations and trade assets that are worth less for those that are worth more.  In doing so, one maintains exposure to the overall risk of the markets, but shifts to more promising areas.

But what if valuations get so strained that future returns from most risk assets are tepid?  At that point, buy-and-hold turns into sell-and-wait.  It’s like being a bond manager — if the excess returns are small from taking additional risk, you don’t take additional risk.

I tend to turn over my portfolio once every three years.  That to me is a good tradeoff between holding for a long time and recognizing that opportunity changes over time.  But my trading is driven by analyzing relative opportunity, selling what I think are lower future cash flow streams for larger cash flow streams.  Do I have a crystal ball to tell me which is better?  No, just business judgment.  As Buffett says, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”

My business judgment has done well for me over my career, but I don’t pretend that it is infallible, because I make significant mistakes.  Humility is an asset to the investor, because we don’t always know the right course.  That said, let diversification handle uncertainty, and within risky assets trade away less promising assets for those with more promise.

A reader wrote me, one who works for a prestigious university and he said:

Since 1926, the minimum inflation-adjusted total return of the S&P 500 (or its predecessor index) has been over 4%, annualized, over every 40-year rolling period.  For 20-year periods, the returns are typically either high (say 9%) or low (say 2%).  Thus, the buy-and-hold investor is best off with the 4-decade hold time.  Fortunately, 40 years matches the typical work life of a person, so workers ought to be shoveling retirement money into equities, and leaving there when they retire, if history is any guide.

 Your thoughts?

Yes, so long as your government holds together, over longer periods of time we do better.  But the tough part for retirees is “What is my situation like when I retire?  Yes, I built up a pot of assets, but what will that buy in terms of continuing income, and will that do well against declining purchasing power?”

There is no magic bullet.  I try to solve this by shifting industries over time, aiming at the most promising current opportunities, but not leaving the market in entire.  I limit cash to 20% of the portfolio when valuations are strained for he market as a whole.

Back to the question, yes, I think most people should buy-and-hold, if they can’t analyze the asset markets.  That’s like the Biblical proverb that a fool is counted wise if he is silent.  But for businessmen/investors there are often relative opportunities to do better.  Analyze those opportunities and take the best of them.

Yes, have some exposure to risky assets for your career, but vary the amount of exposure, and where it goes relative to likely opportunity.

I appreciated Jonathan Burton’s piece Speed kills, but so does complacency.  Like me, he is trying to strike a balance between hyper-trading and permafrost.

My mother is a good example here, though she does things differently than I do.  She holds stocks for a decade or so on average, and analyzes to see whether they have long-term prospects.   She buys, holds, and occasionally adjusts.  She spends more time painting, for which she has a degree of reputation.  She beats average asset mangers regularly.

The main idea should be one of relative value: trade to improve.  Look at the underlying cash flow streams if you can, and trade smaller for larger.

Here’s one more tool to help you.  When the amount of money into an asset goes parabolic, it time to leave.  It is rare that large amounts of additional money will yield excess returns.  This simply admits that there are times when it is wise to reduce exposure to risky assets.  just as bond managers look at yield spreads to commit capital, so should investors in risky assets aim for a margin of safety in what they invest.

As a final note, buy-and-hold is a fundamental strategy in investing.  It presumes that you spent the time analyzing whether this asset was undervalued.  If it becomes overvalued, it does not mean you should hold it.  Always look for better relative value.  In the end that leads to better portfolio performance.






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Asset Allocation, Bonds, Industry Rotation, Macroeconomics, Personal Finance, Portfolio Management, Stocks, Value Investing | RSS 2.0 |

3 Responses to Buy-and-Hold Can’t Die, Redux

  1. [...] trading, which is the consequence of what many investors do, is an ongoing problem.  Merkel in a follow-up piece writes that investors have to have a strategic motivation for trading.  In short, every trade must [...]

  2. cold.as.ice says:

    > Always look for better relative value

    This is about looking at what you hold. But you also need to look for relative value when you buy. In our investment club we have a formal process of comparing a potential buy against 1 or 2 of its strongest peers. Often the original wins, but sometimes the peer wins. Perhaps we select VLO and HFC (the strong peer) wins.

    Yes relative value may be baked into your process, but by doing it as a formal last step is a great reminder of why we buy the stock and that it is not an emotional tie to the stock or company.

  3. [...] to see how well that has worked out so far. Perhaps he was on to something after all? Put me in David Merkel’s camp on this one, not at all a bad place to be. Share this:EmailTwitterFacebook This entry was [...]

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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