The Death of Buy and Hold Has Been Greatly Exaggerated

You’ve probably seen the question posed in a newspaper headline. “Is Buy and Hold Dead?” In the wake of the Great Recession, the investment philosophy certainly has come under fire. Yet, as it does every year, the publication of the Ibbotson SBBI Classic Yearbook (SBBI stands for stocks, bonds, bills and inflation) looks back at the market from 1926 and confirms the value of long-term investing.

As Roger Ibbotson, the author of the long-running performance study, has noted, when you measure market performance since 1926, even a terrible decade isn’t enough to ruin returns. Quoted in a recent news story by Chuck Jaffee on the release of the Ibbotson SBBI Classic Yearbook 2011, Ibbotson said, “People need to realize that they are investing for a lifetime. That’s not, for most people, going to be 85 years of being invested, but it’s going to be long enough that the market forces will win out.”

I realize this message may be a tough sell for today’s investors because the last decade was one of the two worst decades over the period studied. (Of course, worse than the 2000s, was the 1930s with the Great Depression.) Yet, the Ibbotson yearbook clearly illustrates that the market rewards investors for their patience. Jaffe quotes the following: If you invested $1 in large-cap stocks at the end of 1925, you’d have $2,982.24 at the end of 2010, for an annualized average return of just under 10%. One dollars invested into small-cap stocks would have grown exponentially larger, to $16,054.70, or annualized returns of 12% spread over the eight-plus decades. Returns on bonds over the 1926-2010 timeframe ranged from 5.4% to 5.9% range, depending on duration and whether the issue was corporate or government debt, while Treasury bill yields averaged 3.6%.

Each year, reading the Ibbotson SBBI Classic Yearbook reminds me of the best investment advice I have ever encountered. According to economist Gene Fama, Jr., “Your money is like soap. The more you handle it, the less you’ll have.” That is, while lathering your soap in the shower appears to create something solid, the rich lather quickly washes away. Similarly, over-managing your portfolio at best creates temporary gains, or lather, that will be washed away by the stream of water that is the efficient market. What’s more, the cost associated with excessive trading diminishes your portfolio, shrinking it like the bar of soap in the shower.

To push the metaphor a little further, how can we ensure that your bar of soap lasts a lifetime? First and foremost, your investments are guided by an Investment Policy Statement (IPS) that can help you avoid the harmful practice of making emotional investment decisions driven by fear or greed or a belief that you can beat the market. Although research continues to prove it’s impossible to time the market, a majority of investors persist in believing they can do just that, pouring money into equities when the market is up, and selling when it goes down, therefore earning substantially less than index returns. To ensure your investment decisions are based on reason rather than emotions, your IPS articulates your investment goals and a plan to reach them, specifying the investment time horizon, risk tolerance, and standards for a diversified, risk-appropriate portfolio you can live with in all markets.

Additionally, when evaluating the merits of a buy and hold investment philosophy in today’s market, I’d point out that more important than deciding whether to buy and hold, is choosing what to buy and hold. Remember, diversification among dissimilar asset classes is the only academically-proven risk control measure that delivers consistent, and potentially enhanced, returns. Not withstanding the across-the-board decline during the recent recession, spreading your money between stocks, bonds, and cash—asset classes that historically have responded differently to market conditions—is still your best defense against being hurt by poor performance in any one asset class. History teaches us that, like a seesaw, as some investments decline, others rise to offset those losses. Additionally, you should diversify within asset categories by sub-asset class, even by investment style. Note, too, that diversification in any asset category is always achieved more effectively through asset class mutual funds rather than with individual stocks. That’s true of all portfolios and in any market.

I’d add that today more portfolios are benefitting from greater global diversification. After all, while the S&P 500 was basically flat over the last decade, a globally diversified portfolio fared much better. As our government’s debt increases, the developing world, including Brazil, India and China, continues to record substantial growth. Thus, while conventional wisdom has suggested investing a small percentage of your stock portfolio abroad, it may be time to increase that allocation, especially given that more than 60 percent of the world’s total stock market value lies outside of the United States.

In addition to keeping you motivated to save and focused on your long-term big picture, your IPS allows you to measure your progress and decide when portfolio changes are necessary. Our definition of buy and hold has never meant mean “set it and forget it.” Rather, we regularly review portfolio performance and your goals. Of central importance to our rebalancing decisions: Changes to your portfolio come only in response to changes in your personal circumstances and needs, never as a knee-jerk reaction to market swings.

The buy and hold approach to investing often slips out of favor with an investing public that is eternally interested in the next big idea. Whenever you are tempted to change course, remember that buying and holding a diversified portfolio is supported soundly by academic research. History teaches us that patient investors reap market rewards for their ability to resist short-term solutions and invest for the long-term.

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