Should We Finally Bury Buy and Hold?
Sep 19th 2011 12:10PM
Updated Sep 19th 2011 12:12PM
I found it interesting that when I Googled "buy and hold," there were two links right next to each other that respectively read, "Buy and Hold is Dead" and "Buy and Hold Isn't Dead." If you are wondering, the "Buy and Hold is Dead" was the higher-ranked link.
Far from a new issue, this has been a hot debate for a long while. Opponents were laughed at during the dot-com bull run, while proponents were buried during the ensuing crash. Fans had another short time in the sun as the real estate and finance bubbles propelled the market, and ever since then naysayers have been hard at work with their shovels.
One of my favorite publications, The Economist, took one of the most recent swipes at buy and hold in its Buttonwood column. The attack focuses on a long-term asset study conducted by Deutsche Bank (NYS: DB) that showed that equity returns in countries outside of the U.S. have shown a very different story than the U.S. when it comes to long-term equity returns. Further, Deutsche projects that real returns for the U.S. over the next decade will be an awful 0.6% per year. Apparently feeling that buy and hold had sufficiently been fully dispatched, Buttonwood concludes that:
[T]he alternative to buy and hold is to try to trade your way through the cycle, a very difficult process that by definition cannot be achieved by the average investor. But this is the inevitable hangover after the debt-fuelled party of 1982-2007.
Is The Economist right? Have the proponents of long-term investing been leading investors over a cliff? I happen to think they're right ... and wrong. Let me explain why.
The crux of the matter
If I learned anything from Bill Clinton -- besides the danger of Big Macs -- it was that semantics matter.
As such, in the debate over the wisdom of the buy-and-hold mantra, it's important that we're clear about what we mean when we say "buy and hold."
There is what I consider to be the lazy understanding of buy and hold. That definition takes the phrase at face value and says that the strategy encourages investors to literally buy equities and just hold and hold and hold no matter what. This view assumes that there are really only two ways that you're approaching investing -- this buy and hold approach or market timing. This lazy definition is also the widely-held definition. As defined in Wikipedia:
Buy and hold is a long-term investment strategy based on the view that in the long run financial markets give a good rate of return despite periods of volatility or decline. This viewpoint also holds that short-term market timing, i.e. the concept that one can enter the market on the lows and sell on the highs, does not work; attempting timing gives negative results, at least for small or unsophisticated investors, so it is better for them to simply buy and hold.
However, I, and most of my fellow Fools, don't accept the idea that an investor's only choices are to buy and rabidly hold on no matter what or trying to time the market. Instead, when I say "buy and hold" I refer to a process whereby an investor is buying with the intent to hold long term and benefit from the earnings growth and dividends of a company or a group of companies (in the case of an index).
The buying happens when the equity or index has an attractive -- or at least reasonable -- price tag, and the holding happens as long as company-level problems don't drastically alter the long-term profit outlook and the price doesn't get so wildly high that future returns will necessarily be disappointing.
Working off of this view of buy and hold, I've recently been expressing the view that I'm not keen on investing in broad market indexes right now, but that I see good opportunities in attractively-priced, dividend-paying companies with businesses that I expect to be very successful over the long term. These include Wal-Mart (NYS: WMT) with a forward price-to-earnings ratio of 11.1, Intel (NAS: INTC) with a P/E of 8.7, and Aflac (NYS: AFL) with a P/E of just 5.4.
The key is that it's not about buying blindly or timing the market. Instead, it's about having a sense of the business that you're investing in and what it is likely worth. From a more macro perspective, you could say something similar about the economy and the group of, say, Dow Jones (INDEX: ^DJI) companies.
The portfolio nutrition tradeoff
If you want to retire, you have a need to invest just like you have a need to eat. To satisfy the latter, some people are willing to pay others -- often very hefty sums -- to prepare food for them at fancy restaurants. Others don't want to cook for themselves, but also don't have money to blow on fancy restaurants so they grab fast food. Still others want to save even more money and do just a slight bit of work so they buy TV dinners at the grocery store. Finally, some folks learn to cook for themselves.
With investing it's very similar. Individuals with high net worth have savvy investors available to them, whether they be Goldman Sachs (NYS: GS) HNW advisors, hedge funds, or the like. Meanwhile, the folks that read this site and keep the Foolish community humming know well what it means to do the cooking for themselves.
And how does lazy buy and hold fit into this? In the spectrum it's somewhere between fast food and TV dinners. For those that don't have a massive portfolio and don't have the interest or time to really do it themselves, lazy buy and hold -- particularly if you stick to index funds -- is a cheap and often nutrient-deficient way to get the basic job done.
If somebody came to me and asked whether they should choose to eat Hungry Man dinners every night or forgo eating altogether, I would grudgingly recommend the frozen fare. Likewise, if somebody asked me whether they should go for the ol' add-monthly, dollar-cost-average, lazy buy and hold with a mix of bond and stock index funds or not invest at all? I say go for the lazy buy and hold.
Not surprisingly though, I think investors willing to take the cook-for-yourself approach can do better since they can take an informed buy-and-hold approach and choose their own ingredients to make a much tastier and healthier portfolio. And on that note, if you're looking for some great stock recipes, I suggest checking out the 13 that my fellow Fools serve up (for free) in "13 High-Yielding Stocks to Buy Today."
At the time this article was published The Motley Fool owns shares of Wal-Mart Stores and AFLAC. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, Intel, and AFLAC. Motley Fool newsletter services have also recommended creating a diagonal call position in Intel and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Wal-Mart and Intel, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.
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