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Why Does Buy and Hold Have to be Impossible?

October 8, 2015

Why Does Buy and Hold Have to be Impossible?

Dr. Andrew Lo, a finance professor at MIT, recently shared his thoughts on a long-term, buy and hold strategy in an interview on MarketWatch:

“Buy and Hold might sound like good advice because on paper when you take a look at the S&P over the last 10, 20 or 30 years the performance looks pretty good the longer you go. The problem is that advice is just not realistic. You can’t expect an investor to live through 2008-2009 and be perfectly happy to see their investments decline by 50 percent.

It’s not credible to say to an investor, ‘Here’s a stock fund, you ought to just keep your money in it and don’t worry about it and leave it there for 10 or 20 years,’ That’s like telling a teenager he or she ought to abstain; it might be reasonable advice in the long run, but in the short run it’s very difficult to follow.”

The takeaway here is that, sure, long-term investing makes sense, but it’s just too hard to put into practice. There are psychological issues that make it difficult to think and act for the long-term, but what other choice does the average investor have? Chase past performance? Time the market? Pick the best performing asset classes ahead of time? Trade more often? These have all been proven to be losing strategies over the long term.

Being disciplined means accepting short-term unhappiness for long-term results, regardless of how difficult it is. The Marketwatch interviewer provided a good response when he said that he himself was a long-term investor, but feels that many in the investment industry do try to portray taking a long-term stance as being too hard in an effort to sell complex products or unnecessary services that promise to “reduce volatility” to nervous investors.

With the broad U.S. stock market once again at or around all-time highs it’s worth noting that a true buy and hold strategy has never failed to work. However, investor behavior has repeatedly failed a buy and hold strategy. In fact, a study from the Federal Reserve showed that a strategy that followed mutual fund flows (what investors actually did) underperformed a simple buy and hold strategy (what investors should have done) by up to 5% a year. Over 7 years the total performance difference was as high as 40%.

It also makes sense to define what a buy and hold strategy really is. Very few people start out with a pile of money to make a single purchase and then hold on for dear life. Investors make contributions over time and eventually take distributions for spending purposes. A more realistic interpretation is buy & hold…and then buy & hold and buy & hold some more. It’s not guaranteed to work in the future, but I can think of much worse strategies. Is it an easy approach? No. Like all investment approaches it can be feast or famine depending on where we are in a given cycle.

The framework of buy and hold is also really only a starting point. From there, it can be buy and hold AND determine a reasonable asset allocation AND utilize broad diversification AND rebalance periodically to stay within a stated tolerance for risk AND stick with the plan for the long-term. Every investment strategy goes through times when you feel like a hero and times when you question the plan. Every plan also has psychological barriers. Prussian General Carl von Clausewitz once said, “The greatest enemy of a good plan is the dream of a perfect plan.”

Buy and hold is a good plan for most investors. It’s highly imperfect, but there are no perfect plans. Investors have to ask themselves if there really is a better route to increase the probability for long-term success.

It is our strong belief that to be successful in reaching your goals it is necessary to have a plan in place and to follow a process. That is, to make your life and financial decisions not by accident but by design.

Remember, successful people ACT towards the future they want!

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