Buy and Hold

Market Myth Exposed:  Buy and Hold

One popular investment strategy is the passive buy-and-hold system. Even during bear markets, proponents of buy-and-hold say: “Stay the course! Unless you are in the market all the time, you’re in danger of missing the very best days, and those relatively few days account for a huge portion of the stock market’s gains.”

Proponents have justified the assertion based on a 1994 Ibbotson study of the stock market: If you invested $100 in the stock market in 1926 and simply kept your money there through 1993, your investment would be worth $80,000. But if you used an active money management strategy and “missed” the 30 best months, your $100 would have grown to only about $1,200, the same return you would have received investing in U.S. government T-bills.¹

At first this sounds compelling: Why would anyone want to take the chance of missing out on $78,800 or 98% of the gain? However, proponents have not told the whole story: What if you employed an active management system and could avoid the 30 worst months from 1926 through 1993? Your $100 initial investment would have grown to around $8.6 million.²

Now, what if you made a $100 investment during these 67 years and employed a less-than-perfect active management system that caused you to miss the 30 best months while helping you miss the 30 worst months? Your $100 investment would have grown to $120,000 vs. $80,000 for buy-and-hold, 50% more net dollars than the buy-and-hold investment with less volatility.² Thus, it appears the risk of missing the good days is less than the risk of being exposed to the bad days.

Many investors simply don’t want to “stay the course” and watch their portfolios drop as the stock market and the economy turn from bad to worse – as it did from January 1999 through January 2009. During that time, the worst 10-year stretch in the history of the S&P 500, an investor holding the stocks in the S&P’s 500-stock index, and reinvesting the dividends, would have lost about 5.1 percent a year after adjusting for inflation.³

Many investors, especially retirees and those nearing retirement, can’t afford to wait out or try to rebound from stretches like that. They want an active investment system that can help them grow their assets during up-trends and preserve the value of their portfolios during market downturns.

 

¹Ibbotson, Roger G., and Rex A. Sinquefield. Stocks, Bonds, Bills and Inflation: Historical Return (1926–1993). Chicago: Dow Jones–Irwin, 1994.

²“The Myths and Realities of Market Timing,” by Paul Merriman, Merriman Fund Advice, June 29, 2005. www.fundadvice.com/fehtml/mtstrategies/9410.html

³“A 10-Year Stretch That’s Worse Than It Looks,” by Floyd Norris, Feb. 7, 2009, New York Times (p. B3, New York edition).

Who do you think you should send this to right now?