Buy & Hold Investing - The Hype and the Reality. December 9, 2002.

As was pointed out in Sy's 1999 book Riding the Bear - How to Prosper in the Coming Bear Market, those who advocate a buy and hold strategy for investors play a dirty trick on them. Not only is the theory itself, based on the fact that “the market always comes back", deceptive, it’s entirely bogus.

The first and perhaps most obvious problem with buy and hold investing as a viable strategy is that a buy and hold investor, by definition, is guaranteed to suffer every correction, crash, and bear market that the market experiences. Over the last 100 years there have been 21 bear markets, one on average of every 4.8 years. Their average declines were 36% (if one were invested only in the stodgy stocks of the Dow). The ten worst bear markets averaged declines of 49% in the Dow.

That kind of repeated abuse doesn’t take long to have most adherents give up on the strategy. Unfortunately that realization always takes place at a market low, after a bear market has devastated their portfolio. In other words almost every buy and hold investor is going to wind up being a market-timer, but with the worst of timing.

Meanwhile, the sales pitch for buy and hold is bogus anyway, even if one could hold through the repeated periods of extreme pain.

The theory is based on the fact that the market indexes, the Dow, S&P 500, Nasdaq, etc. always eventually come back to their previous levels. However, the make-up of those indexes undergo such constant change and 'rebalancing' that the fact that they always come back does not come close to meaning an investor’s portfolio will come back. The market indexes are designed to provide a picture of the stocks that best represent the economy. Since the economy is constantly undergoing change, in order to represent the economy the stocks within the indexes have to also change, not only as new products and industries come along, but also as new concepts and companies come along in old industries. Examples being Sears and Woolworth moved out of indexes as representing the retail sector, and WalMart and Home Depot moved in. Previously wildly popular bowling stocks out, casino stocks in. Howard Johnson out, Disney in.

In the bull market of the 1980’s, leading up to the 1987 crash, investors were heavily invested in that era’s favorite stocks, the likes of Amdahl, Control Data, Polaroid, Brunswick, Commodore Computers, Wang Laboratories, Itek, Western Union, Woolworth, etc.

The S&P 500 sure came back after the 1987 crash, but it came back after replacing many of those former winners with the new stocks for the next bull market, WalMart, Microsoft, ToysRUs, Home Depot, Dell Computer, Intel, etc., most of which didn’t even exist in the bull market of the 1980s.

Buy and hold investors of the late 1990s are still holding and waiting for the return of stocks like WorldCom, JDS Uniphase, Global Crossing, United Airlines, Food Lion, etc., and hundreds of others, long since removed from indexes. The indexes will eventually come back. Most of such previously popular stocks will not.

As an indication of the degree to which changes are made in the indexes; in 1999, fully 43% of the stocks that comprised the Dow just 10 years previous, were no longer in the Dow. Some were no longer even in business. Still more have been replaced in the last few years.

Just in the popular Nasdaq-100 index of 100 large Nasdaq stocks, 30 were replaced in 1999, 17 were replaced in 2000, 19 were replaced in 2001, and more than 20 have been replaced or are scheduled to be replaced in 2002. Just in the internet sector, more than 860 companies have filed for bankruptcy in the last two years, their stock now worthless. So again, the fact that the market indexes always come back does not come close to meaning an investor’s stocks will come back.

If investors will only realize they don’t stand a prayer of having buy and hold investing work for them, they will have taken a giant step toward long term accumulation of wealth. It might help to realize that:

Wall Street Doesn't Buy and Hold With Its Own Money

Wall Street tells public investors to simply buy good stocks or mutual funds and hold them forever. Put them under the mattress. Don’t try to time the market, they say. Don’t worry when their prices plunge. Don’t worry about market corrections, or even bear markets, because the market always comes back. Just buy any time and let time take care of it.

But that simplistic advice is not how they handle their own money.

Mutual fund managers for instance certainly don’t practice what they preach. The Morningstar database of mutual funds shows that year after year many of the best performing funds have annual portfolio turnover rates of 100 to 300 percent. Yes, a 100% turnover rate means turning their entire portfolio over on average of every twelve months. A 300 percent turnover rate indicates an average holding period of just four months. What are they doing? They’re taking profits when they have them and moving on to new holdings. The Fidelity Magellan fund, in the period when it was managed by Peter Lynch and earned its reputation as the best performing fund of all time, had a portfolio turnover rate approaching 300 percent in most years. But of course now that he is a spokesman for Fidelity Funds and not a fund manager, Lynch advises public investors to simply buy and hold since "the market cannot be timed".

Brokerage firms trading for their own accounts engage in market timing with even shorter holding periods. Their program trading, which consists of the instant buying and selling of huge baskets of stocks based on computer signals, accounts for more than thirty percent of the volume on the NYSE. As even casual observance of program trading activity reveals, most days their holding period lasts no more than a few hours.

We know that corporate insiders - the managers and largest stock-holders of corporations - don’t want us trading in and out of their stocks. But how do they handle their own holdings? They can’t hide their activity. SEC regulations require insiders to file all changes in their stock holdings in a timely manner. Month after month, year after year, those filings clearly show how persistently and successfully company insiders trade in and out of their company’s stock, selling after the stock has rallied, buying back after it has declined to lower levels. They’re so successful with their market timing that Wall Street professionals watch insider buying or selling in specific companies as a guide to their own investments.

Even famed billionaire investor Warren Buffett, who encourages his reputation as a buy and hold investor, has a history of significant market timing. Buffett made his first millions running a private investment partnership for wealthy investors. It’s no secret that after making huge gains in the mid-1960’s bull market, he demonstrated exquisite market timing at the bull market peak in 1969, by taking the profits, liquidating the partnerships, and returning the assets to his investors.

More recently, SEC filings show that Buffett began taking profits from the 1990s bull market in July, 1998, raising a huge $9 billion in cash, and used the big market rallies thereafter to take still more profits, until by October, 1999 he was sitting on an estimated $40 billion in cash. His remarks about the situation are interesting. “I don’t like holding cash, but I dislike being foolish even more.” Who was he selling all that stock to in 1998 and 1999? Public investors, taken in by his assurances that Coca-Cola, Gillette, General Electric, et al, were the type of stocks you could just buy and forget about?

Wall Street insults public investors by engaging in significant market-timing for their own money, while implying that market-timing is beyond the ability of public investors.

Our Seasonal Timing Strategy is but one strategy, needing not much more than the ability to read a calendar, that consistently out-performs the bench-mark S&P 500, which is more than most mutual funds and professional money-managers can claim. And it does so with 50% of the market-risk taken by buy and hold investors.

And our non-seasonal strategy (based on technical analysis using overbought/oversold conditions, support and resistance levels, investor sentiment, momentum-reversal indicators, etc.), allowing investors to go both long for rallies and short for corrections, also provides substantial advantages over buy and hold, (as well as over standing aside and not participating).

But buy and hold investing does not, and cannot, work. The advice from Wall Street and corporations that it does, is self-serving and bogus