Buy and hold, according to Wikipedia, is an investment strategy where an investor buys stocks and holds them for a long time. This is based on the view that in the long run the financial markets give a good rate of return despite some negative volatility, that is, declines. As though there is no better idea, this viewpoint holds that market timing, for example, does not work for small or unsophisticated investors, so it is better for them to simply buy and hold. Three points are in order here:
- First, this isn’t a discussion about market timing.
- Second, there is the false assumption in the definition that the only other option is attempting to time the market.
- Third, and most importantly, buy and hold always works when you don’t need the money. After all, when you don’t need income, does it matter to you if your account goes up 90%? How about if your investment were to lose 90% of value? In both cases, if you don’t need the money, the value really doesn’t matter.
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Please see the chart below for another idea that might have worked for you.
From 1/1/01 through 6/30/14, notice in blue how the S&P 500 index performed. This result makes the buy and hold crowd happy. As you can see, $1M experienced two significant bad years but came back to even in late 2012, and by 6/30/14 was valued at $1,484,685. What most investors haven’t been shown is how additional diversification could have added over $331,000 to the bottom line during the same time. Conventional -investing wisdom taught us that good years will offset bad years. On the other hand, it may be that what is true in every sport, that a good offense is a strong defense, may be true when it comes to investing too. Instead of hoping for returns that might eventually put your money back in the black, it may be smarter to limit one’s losses. You may like to see how you might have kept your losses to -20% or less so that you only need a gain of 25% to get back to even.
Notice how by adding two more asset classes to your portfolio in the blended benchmark you accomplished two goals. First your loss did not exceed -20% and second your account value ended 6/30/14 at $1,816,595 a gain of 23.71% higher value as compared to stocks alone as measured by the S&P 500 or $331,910 more money to your bottom line. Past performance is no guarantee of future success and it is not possible to invest directly into an index. At the same time, it is good to see the evidence that investors might have held up better than they have been led to believe.
Now, let’s turn our attention to a very realistic scenario where income needed to be taken. On 12/29/10 the Pew Research Center says that “Roughly 10,000 Baby Boomers will turn 65 today, and about 10,000 more will cross that threshold every day for the next 19 years.” So let’s be realistic, as folks who are approaching retirement could have a bad experience once withdrawals occur on top of a severe market decline year or two. By starting with the same $1M and assuming $60,000 annual withdrawals were needed for income, you can see in blue by 6/30/14 the account is left with about $160,000. Wasn’t that great; the money is gone and you are still here. In the more diversified portfolio, however represented in green, the account stands at about $527,000. In both cases, the withdrawals add up to $840,000. We are encouraging you to see what you might need to do to stay in the game through retirement.
Forbes contributing author, Robert Laura wrote, “Wake Up! Buy and hold doesn’t work.” Laura went on to say, “I’m losing patience with financial rules of thumb especially the tried and true concepts of ‘Buy & Hold’ and infamous ‘Buy Low & Sell High.’ Not only does the ‘Buy & Hold’ concept lack relevance in today’s markets but technically you can’t apply both a ‘Buy & Hold’ strategy with a ‘Buy Low & Sell High’ approach.” Your mood and your financial success can change drastically when income is required. To be better prepared for the unforeseen, take the time to do your homework. Ask your current advisor to:
1) Back test your results and holdings from 2001-2014.
2) Identify ways to diversify unlike you ever have before.
3) Identify active management strategies that work to take money out of risky assets in a bad year and put that money back in risky assets when the fundamentals appear to be stronger. If you don’t understand or like the answers you receive, please get a second opinion.