How to Invest Using the "New" Buy and Hold

It's been a trying couple of years for the stock market -- the kind of trying times that shake fundamental market beliefs.

Investments in one-time stalwarts like AIG (NYSE: AIG  ) , General Electric (NYSE: GE  ) , and Citigroup (NYSE: C  ) shocked us all when they toppled from their perches. The severe market losses have caused many to question whether the cornerstone of value investors, "long-term buy and hold," still works.

A new normal
In an exclusive Fool interview earlier this week, Mohamed El-Erian, the CEO and co-CIO of Pacific Investment Management Co. (the world's largest bond investor) said long-term buy and hold is not dead. However, it has to be modified for a "new normal."

Translation: We are undergoing secular changes, not cyclical ones. The environment as we knew it before the financial crisis isn't going to return anytime soon.

By El-Erian's account, there will be a new normal brought on by de-leveraging, de-globalization, and re-regulation. Specifically, the new environment is characterized by languid gross domestic product (GDP) growth and high unemployment for some time. The government will play a large role in the private sector, consumers will not spend to oblivion as before, and the trust that has been broken in financial and regulatory sectors will take time to restore.

To that end, El-Erian recommends that investors build a portfolio based on three elements:

  1. A long-term view.
  2. A cyclical view.
  3. Very explicit risk management.

The elements
The first element of the strategy is to be forward-looking rather than backward-looking. "That speaks to asset allocation and geographical exposures," El-Erian said.

The second element is that the road forward will be mired with sharp turns and bumps. As a result, investors must position their portfolios to benefit from cyclical trends. "That bumpiness constitutes an additional challenge for buy and holds, which is to make sure that people can in fact hold -- because when you have a very bumpy journey, there is a temptation to stop holding at the wrong time," he said.

"So there has to be a much more responsive element of the portfolio that is looking to capture not long-term secular and structural trends, but looking to catch shorter-term cyclical and technical trends," he said.

The third element of El-Erian's plan is conscious risk management, which gets at diversification. In the past, El-Erian said, one of the problems with the buy-and-hold strategy was that it encouraged people to think that diversification was sufficient for risk mitigation.

"That's no longer the case. Diversification is necessary, but it's not sufficient," he said. It's necessary because it's the best method for mitigation of risk, but it's not sufficient because, as El-Erian points out, you can have years, such as last year, in which all the correlations go against you. Therefore, he said, buy and hold needs to be supplemented with much more responsive risk management.

"It's not enough to say I'm going to be able to buy and hold simply because I'm diversified. One has to go a few steps further and ask what does it look like when I'm actually buying and holding?" he said.

Building on that, El-Erian said a portfolio should be constructed such that only part of it is held for the "long term," which he defines "long term" as three to five years, max -- because it's difficult to forecast what happens much beyond that. "Part of the portfolio is buy and hold where values are going to be realized over a period of time," he said. "What the investor is taking advantage of is the ability to buy and hold, because there are lots of pools of money that cannot hold up through the ups and downs of a market."

More cracks in the "old normal"
To deal with this new normal, El-Erian has some more tactical advice:

  • Start out by defining your objectives and your risk tolerance, because both determine how you build up your portfolio. "The more ambitious you are on your objectives, the more risk that you're going to have to be able to tolerate."
  • Indexing may not work as well as in the past. In unstable conditions, "it's important that the core product be actively managed."
  • Investing only in the U.S. could lead to subpar returns, since the U.S. will grow more slowly than the rest of the world.
  • Blue chips like Wal-Mart (NYSE: WMT  ) and McDonald's (NYSE: MCD  ) will be around for years to come, but they won't dominate the markets, or investors' portfolios as in the past.
  • Inflation is a potential portfolio danger. The best way to guard against inflation right now is with Treasury Inflation Protected Securities (TIPS): "Investors can also protect their portfolios with real assets, but TIPS certainly offer you the more predictable protection against inflation."

Do you agree with El-Erian? What about The Motley Fool's very own Tom Gardner? Join our debate on whether buy-and-hold investing is dead by reading more and by using the comment box below.

Jennifer Schonberger does not own shares of any of the companies mentioned in this article. Wal-Mart Stores is a Motley Fool Inside Value recommendation. The Motley Fool has a disclosure policy.


Read/Post Comments (20) | Recommend This Article (79)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 11, 2009, at 4:49 PM, theHedgehog wrote:

    No matter what you call it, market-timing is market-timing - it's not "buy and hold" investing.

  • Report this Comment On June 11, 2009, at 5:16 PM, captainccs wrote:

    >>>by de-leveraging, --> yes

    >>>de-globalization, --> no, not unless you change the laws of economics

    >>>re-regulation --> some

    >>>he defines "long term" as three to five years, max -- because it's difficult to forecast what happens much beyond that. --> That's not how "long term" works. You buy for long term and sell when the time comes which could be 5 years or 10 or more or it could be a mistake and you sell sooner.

    Every stock is a story of its own. Why box yourself in as LTBH or trader or whatever? Why not be pragmatic and manage each stock according to its merits and quirks?

  • Report this Comment On June 11, 2009, at 5:36 PM, 7footmoose wrote:

    Buy and Hold is dead or at least doing a Rip Van Winkle, largely due to the computerized trading used by Mutuals, Hedges and Large Institutions

  • Report this Comment On June 11, 2009, at 6:40 PM, bebop111 wrote:

    A lot of words for something that doesn't really give much guidance.

  • Report this Comment On June 11, 2009, at 7:14 PM, MyPiggyBank888 wrote:

    GE, AIG aren't they Global? Yes, we held on to these long term blue chips, but they over leverage to go global. If we are buying a stock, let's do it on the term created by the fool's. If you leverage beyond the parameters established by us, the ones with bells in our head, then we won't recommended you to our friends. Fool On!

    PS. Only a retard, not a fool, pay's for advise and doesn't follow it!

  • Report this Comment On June 11, 2009, at 7:39 PM, jc09058 wrote:

    De-globalization? Hum... Some of the major corporations that seem to have weathered this financial down-turn have some degree of globalization, so it would seem to me that is taking a wrong course. If anything, with the dollar exchange rate and inflation issues both looming just over the horizon, I would think globalization would be the one way to help protect your portfolio.

    Long-term is value laden judgment based on a person or persons best guess as to what the future holds. Yes, I do look long-term as best as I can but I always temper that view by re-evaluating my investments yearly or more often quarterly to see if they are still on track. Granted reviewing the news for specific companies or industries is done daily to watch for surprises.

    Buy-and-Hold still works as long as it is Buy-and-Hold-and-Review. Anything else just insures you will more than likely grow poor by neglect.

  • Report this Comment On June 11, 2009, at 7:47 PM, goalie37 wrote:

    "Buy and Hold" becomes the"New Buy and Hold." We'll change the system, just keep the name. Intellectual dishonesty at best.

    What we need to throw out are these automatic, brainless concepts accepted as common wisdom. Buy and Hold, Dollar Cost Averaging, Diversification. No automatic system can beat a well thought, well researched decision making process.

  • Report this Comment On June 11, 2009, at 7:50 PM, Fliujniligui wrote:

    I use "buy some and hoard if the conditions are met". Conditions are a price drop that is excessive compared to fundamentals (GE, NBG,DB, EWBC, EXFO...). This way, I just invest the way I play Oblivion. You hit the target until you get it. If the company is good, sooner or later, it will stop tanking and you will have one of your purchase who will be near the bottom. It even worked for Allied Irish Banks, and a lot of company are not this troubled.

  • Report this Comment On June 11, 2009, at 8:39 PM, StrivingGenius wrote:

    For me, Buy and Hold is certainly dead when it comes to owning mutual funds. I will no longer pay people to manage my money for me when they really don't care about saving my capital or minimizing my losses. They make money regardless, and are largely uninterested in defining mutual funds that state these as goals while utilizing stocks for higher returns.

  • Report this Comment On June 11, 2009, at 9:13 PM, oldgator52 wrote:

    I have read a convincing argument that "globalization" is going to be changing. The idea is that with the decline of the dollar and the steep increase in all transportation costs(mainly due to fuel) the U.S. will be forced to re-establish a manufacturing base that will serve principally the domestic economy. This trend will , to some extent, effect other national economies as well.

  • Report this Comment On June 11, 2009, at 9:22 PM, kv1000 wrote:

    Yes, buy and hold is dead. Extinct.

    Financial planners, advisors, insurance sales, mortgage brokers all should be dead too! Here are these guys who have been collecting up to 10% of the assets of a new investor, who have no risk. Their only tool is to tell you that yu are ignorant, or you are going to die in your home without any care. So should be all the mutual funds which charge loads and tie up the capital for years... I would really like to see mutual funds be replaced by low cost ETFs. But I dream on! Why? A fool is born every minute... actually every second.

  • Report this Comment On June 11, 2009, at 10:01 PM, JaBeBuBo wrote:

    If you have a PURE STOCK PORTFOLIO then use the LTBH strategy and if you have multi ”vehicle” 401k use a Market Timing strategy. My LTBH account is not looking nearly as good as my Retirement Acct but it is “long term”. My retirement account is pulling in close to 27% since Jan. 01,2009. That is SWEET!!!!

  • Report this Comment On June 11, 2009, at 10:44 PM, Redbaron64 wrote:

    I think one cannot just look at equities in isolation but must be in relation to T-bills and forex markets. With so much liquidity being pump into the markets, its (on hind sight) logical for equity markets to recover. BUT some thing got to give - when T-Bills gives record returns ... does it mean that the overall value of that "returns" will diminish in the long run? Given all the $$$ that is being printed? Even if US markets stablised or move higher, if the $$$ weakens what will happen to the true value of one's holdings vis a vis other investment opportunities in other currencies or overseas markets?

  • Report this Comment On June 12, 2009, at 6:21 AM, dasilook wrote:

    what buy and hold, i started with four hundred thousands in 1997 and today it is worth fifty thousand, what you call it long or short term.

  • Report this Comment On June 12, 2009, at 1:48 PM, Shiroto wrote:

    Buy and hold has been refined as buy and hold on to your seat, or your hat, or really whatever you can.

  • Report this Comment On June 12, 2009, at 7:20 PM, 102971 wrote:

    I have used one basic rule for over twenty years. If a stock I hold shows a profit of 100% I sell half of it. If the remaining half then continues up to also show a 100% profit, I sell half of that ans so on.

    If that stock subsequently falls to at least 25% below my INITIAL purchase price and the fundamentals haven't changed I will buy it again and follow the same pattern.

    However, if I bought a stock at, say $50 a share and within three weeks it has gone to $75, I will sell it and take my short term profit and say thank you.

    On the dowside if a stock I have bought falls 25% within six months of my purchase, I will say "goodbye" and sell it.

    This is neither short term nor long term investing. It is known as making as much profit as you can. I don't wait for the "ten baggers", They are too few and far between.

  • Report this Comment On June 12, 2009, at 7:59 PM, WishToRetire wrote:

    Risk management requires truthful information upon which to base decisions.

  • Report this Comment On June 15, 2009, at 9:41 PM, REIN wrote:

    It is amazing how wide the spectrum of interpretations of LTBH. In its most literal interpretation, I guess you would have bought GE (or SPY) back in 1997 (GE was $12 - $18 per share, split and dividend adjusted) and today GE is back at $13. Of course if you were really this literal about LTBH then you should still be holding and certainly the price is going back up again. Anybody who lost 75% of their capital in that time frame must have been day trading (that was my turn to paint with a broad brush). Of course my interpretation of LTBH includes the quarterly reviews of the holdings as any Fool should. When a stock has tanked or continuously fails to perform you need to cut your losses. Of course this too often, too late. But when you hold your winners they will make up for these losses. LTBH with quarterly reviews is up over 100% since 1997 (or 8% annualized). Of course my LTBH had seen that same 100% gain by Y2K or 32% annualized. And I had seen 200% gains (or 14% annualized) by 2005. A person is tempted to think, If only I had sold at the top, but which one? Then you will miss the next run up, as you will certainly will if you are out of the market now. Similar to anothers comments, I'm up 50% since the lows of Nov-Dec.

  • Report this Comment On June 19, 2009, at 5:24 PM, Clustershock wrote:

    I'm surprised he's recommending TIPS. I get the interest rate portion of it, but the underlying treasuries will get slaughtered come the next auction. I would avoid those in favor of infrastructure.

  • Report this Comment On June 19, 2009, at 11:59 PM, jerryguru69 wrote:

    "he defines "long term" as three to five years, max ".

    Interesting. If you keep redefining what "buy and hold" means, then of course it is not dead.

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