Buy & Hold: A Historical Perspective

To we continue with Monday's theme of examining the concept of buy and hold (B & H) from a historical perspective. Before we begin, I want to step on my soapbox for a moment and look at how most of us are duped into thinking that this is the superior stock strategy. I have two words for you: Warren Buffett. Don't get me wrong, I respect and admire the Oracle of Omaha for how he manages both his personal and professional life. I believe he's a person of great integrity and of course he possesses an astoundingly astute sense of business. But what I don't like is how people have taken his business philosophy and applied it to their own situation. “If it works for Buffett, it's gotta work for me.”

Why B & H works for Buffett
But does it? Is there perhaps a difference between Joe Investor and Warren Buffett? Besides $50 billion or so? Yes, there is—and the difference is a big one. First of all, Buffett has a cadre of lackeys who do nothing but pore over company financials searching for the next big bargain. When they find one, Buffett steps in and wangles a great deal. He's able to do that because he knows how to do it, he has oodles of dough, and because he is, well, Warren Buffett. Now that he owns the company, he can insert his own management team or he can “guide” current management and let them run the business with them knowing that at any time they could be ousted. You'd better believe that Buffett will try to do everything he can so that his latest acquisition won't fail, because if it did, he might lose the Oracle title and I'm sure he wouldn't be happy about that.

Can you see the difference between Buffett's buy and hold strategy and yours? You buy into a company hoping that what is written on its balance sheet accurately reflects its current condition as well as future sales projections. But unless you're very wealthy, you won't have the means to buy enough shares of the company to have a say in how it's run. For example, you can't tell the CEO that if his company doesn't meet expected benchmarks, he won't get his year-end bonus nor his stock options, can you?

Even John Bogle, the founder of the Vanguard Group (of mutual funds), firmly adheres to the buy and hold forever strategy. (See his “Little Book of Common Sense Investing.”) The key word here is “forever.” Yes, buy and hold works when your time horizon is on the order of 35+ years, but many of us don't have that luxury. So, how effective is it in the shorter term?

When B & H doesn't work
Let's take a look. Here's a chart of the Dow Industrials from 1905-2005.* You'll see that there have been three major bull markets in which the vast majority of gains were made interspersed with three bear markets where gains were negligible. Note, too, that the length of bear markets is much longer than bull markets, with the average being 19 years compared with 12.

Let's look at several examples of what a pure buy and hold strategy might have produced.

Example #1: A 30 year old man starts a retirement account in 1930. If he wants to start drawing from it at age 55, he will have had no gains at all! And if you count in a 3% annual erosion due to inflation, he'll have considerably less. Twenty-five years is a long time to suffer. (Yes, I know in hindsight this is the worst case scenario, buy hey, stuff happens and there's no guarantee we're not looking at a similar situation today.)
Example #2: A 38 year old woman starts her retirement account in 1966. She finds that when she wants to start withdrawing from it 17 years later there's less there (due to inflation) than when she began.
Example #3: A follow-the-herd investor finally jumps on the tech bandwagon near the end of the bubble when the Nasdaq was trading around 4500. Nine years later, his portfolio is down 63% in asset value alone.

Do not let this happen to you! Sure, asset allocation may help counteract the losses caused by poor market timing but very little in today's environment (other than holding short positions) will help you. In summary, buying and holding is for investors with extremely long time horizons and even then, I believe that a market timing scheme, even a simple one, is preferable.

Tomorrow, we'll look at some market timing schemes that anyone can use and see how they compare with each other. Don't miss the rest of this valuable series!

[Note: The chart is in pdf format which means you'll need Adobe Acrobat reader installed on your computer.]