Bill Gross and the Case for Buy Low and Hold

Bill Gross, head of bond giant PIMCO, made news earlier this year by getting out of U.S. Treasuries.

The end of the Fed's quantitative easing, he reckoned, was going to be bad for bonds. Prices would fall, yields would rise.

Whoops. The opposite happened. Yields plunged. After Treasuries were downgraded by Standard & Poor's this month, they posted some of their best days in history.

Bad news for Gross, whose funds have lagged heavily against benchmarks.

He admits his folly, telling The Wall Street Journal the move was a "mistake," and that "we try to be very intellectually honest and honest with the public."

Hey, mistakes happen -- and it's even better when you admit them. But then there's this, from the Journal:

"The Total Return Fund has been adding to its Treasury positions since March, including a jump in July to 10% of its holdings, up from 8% in June. Overall, the fund now has net positive exposure to Treasurys for the first time in months." 

When 10-year Treasuries yielded 3.5%, Gross was a major seller. Now that they yield closer to 2%, he's a major buyer. This wasn't investing. It was an attempt at market timing gone astray -- and it cost his investors big.

This happens more often than you might think -- and more often than it should. As the finance blog The Capital Spectator wrote of Gross' moves yesterday:

"To be fair, Gross enjoys one of the best records among fixed-income managers, even after his 'mistake.' But his ill-timed bet is a reminder that even the smartest of money men can and will stumble at times. The only question is how big the stumble will be? ...

"In order to beat the benchmark, you have to move away from it. It's also true that for those who mint market-beating results, the advantage is financed exclusively by those who made losing bets. In the middle, as always, is the benchmark. And after adjusting for the relatively higher expense of active management, the benchmark is likely to end up as slightly above average. That's true for individual asset classes and for multi-asset class portfolios as well.

"Skeptical? You're not alone. The majority of the planet's investors subscribe to the idea that great success awaits in active management. Nonetheless, you can safely anticipate that half of those who attempt to outguess Mr. Market will end up with below-average results."

Not coincidentally, multiple studies confirm that those who trade the most perform the worst. In his book Enough, Vanguard founder John Bogle writes of "the relentless rules of humble arithmetic":

"The gross return generated in the financial markets, minus the cost of the financial system, equals the net return actually delivered to investors.

"Thus, as long as our financial system delivers to our investors in the aggregate whatever returns our stock and bond markets are generous enough to deliver, but only after the cost of financial intermediation are deducted, the ability of our citizens to accumulate savings for retirement will continue to be seriously undermined by the enormous costs of the system."

Most investors could improve their returns by pounding these simple rules into their heads. Trade more, earn less.

In past lifetimes, these rules were followed with a case for buy and hold. If you can't outwit the market, just be the market. Buy stocks. Hold them for a long time. Enjoy the beach in between.         

But things get itchy during a multiyear sideways market cycle like we're in now. When the benchmark returns zero (or less), the desperation to beat it grows exponentially. Even companies whose earnings have grown mightily have seen their stocks languish: Microsoft (Nasdaq: MSFT  ) , Wal-Mart (NYSE: WMT  ) , Google (Nasdaq: GOOG  ) , and Johnson & Johnson (NYSE: JNJ  ) all fit that bill. That's the struggle of a market where P/E ratios are compressing. And it gives people the sense that they need to trade more to get ahead, which reduces their odds of success even more. It's a world full of frustration and ironies.

But I think there's a happy medium. I'd call it buy low and hold. It goes something like this:

  • Like an active investor, you only buy at what you perceive as opportune times, such as when investments trade below long-term average valuations.
  • Unlike an active investor, your selling plans are primarily influenced by a long-term target goal: retirement, kids' school, etc.
  • Like a buy-and-hold investor, you couldn't care less about what happens in the short run. There are no "whoops, that was a mistake -- let's sell and try again" moments.

The most important variable in any investment is the starting price. In bull markets, you can get away with flubbing that price since the general trend is up. In sideways markets like today, there's no room for error -- nailing that starting price is vital. There's still no excuse for excessive trading. But one can combine the passivity of a buy-and-hold investor with the opportunism of an active investor by buying only when things are plainly cheap and waiting patiently thereafter, regardless of volatility.

This is painfully oversimplified. But so much of what sends investors astray are painfully simple mistakes. Every investor could improve their results by keeping a buy-low-and-hold mentality in mind. Even masters like Gross, it appears.

Fool contributor Morgan Housel owns shares of Microsoft, Wal-Mart, and Johnson & Johnson. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Microsoft, Wal-Mart Stores, Johnson & Johnson, and Google. Motley Fool newsletter services have recommended buying shares of Google, Wal-Mart Stores, Microsoft, and Johnson & Johnson. They have also recommended creating a bull call spread position in Microsoft and a diagonal call position in Johnson & Johnson 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. The Motley Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (27)

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 August 31, 2011, at 11:36 AM, TheDumbMoney wrote:

    Exactamundo.

  • Report this Comment On August 31, 2011, at 1:15 PM, ShaunConnell wrote:

    ...someone once didn't time the market right, therefore you should never time the market. Right.

  • Report this Comment On August 31, 2011, at 1:20 PM, TMFHousel wrote:

    It's more than Gross, Shaun. As the article notes, multiple studies show that those who trade the most perform the worst.

  • Report this Comment On August 31, 2011, at 1:38 PM, Ikarruss wrote:

    In this market, the thesis is good. Buying oportunities abound, selling is not so hot. However I think there is a case for selling high, if you think that your stock is not going any (or much) higher (note that is no the same as thinking it will go down), you should probably sell. The problem is no one wants to sell before you get to the top, and the only way to know it was the top is when you missed it.

  • Report this Comment On August 31, 2011, at 2:17 PM, CrystalBullcom wrote:

    That's funny. On one hand, you advise not timing the market. Then, your first bullet advocates a form of market timing:

    "Like an active investor, you only buy at what you perceive as opportune times, such as when investments trade below long-term average valuations."

  • Report this Comment On August 31, 2011, at 2:21 PM, TMFHousel wrote:

    ^ as mentioned, it's a happy medium between the two.

  • Report this Comment On August 31, 2011, at 2:21 PM, TMFHousel wrote:

    Further, buying cheap is not market timing.

  • Report this Comment On August 31, 2011, at 3:13 PM, ShaunConnell wrote:

    Buying cheap is market timing -- it's when you think the market demand for that stock is going to go up. Timing the market is something everyone should do when it comes to investing. The only question is which strategies work best.

    As for people who trade a lot losing more -- that's not the trading frequency, it's the trading strategy or lack thereof.

    If you're trading a lot because you're flapping around with no clue what's going on, yeah, you're going to lose money. If you're trading a lot because you're cashing in on good calls, then yeah, you're going to make money.

    Correlation =/= causation.

  • Report this Comment On August 31, 2011, at 3:27 PM, hveagle wrote:

    Seems like this investment strategy bears at least a superficial resemblance to special event style investing a la Goldenblatt.

    I think that one of the biggest hurdles for many investors (myself included) to adhering to this kind of plan is the discipline required to accumulate and maintain a sizable cash position. As a possible compromise, I've been considering investing in solid, defensive large caps (e.g. KO) for the intermediate term at those times when I can't find value.

  • Report this Comment On August 31, 2011, at 7:41 PM, TheDumbMoney wrote:

    @Shaun, you said, "Buying cheap is market timing -- it's when you think the market demand for that stock is going to go up."

    This is incorrect. When one "buys cheap," one does so because the market's current informal and semi-educated appraisal of a company (i.e., it's stock price) values it below the level that one thinks it is actually worth. It is timing only in the sense that whenever one does something at a particular moment in time, one is engaged in "timing." But it is not "market timing" in the sense that that phrased is used by non-casual participants in the markets. "Market timing" involves tailoring one's actions to solely to that appraisal price, not to some concept of fundamental value. Those holding and seeking to sell gold at the top of a parabolic rise to $4000 that they foresee are market timers. Those thousands of individuals who bought houses in 2007 thinking they'd sell to some other dude in 2008 for an easy twenty percent profit are market timers. Those convinced they alone will be able to sell NLY at a profit the day interesst rates shoot up are market timers.

    By contrast, those who love a company based on its value and growth proposition, and who have tried to create a valuation estimate, and who suddenly see an opportunity in the market to buy that stock for twenty or thirty-percent below what they believe it is truly worth, are "market timers" in no sense in which the phrase is commonly used.

    Of course, in order for the "hold" aspect of the theory to be true over any significant period, the company must also possess an above-market ability to grow and/or wring out efficencies. From what I have read, value investors commonly trip themselves up on this rock. I know I have. Best of fortune.

  • Report this Comment On August 31, 2011, at 9:08 PM, xetn wrote:

    Buying low is a subjective idea. Nobody know what "low" really is. It may be an historic low, or a low by economic standards, but it is still subjective. It could always (and often does) go lower.

    Buying based on a "low" is a kind of market timing.

    As far as Bill Gross goes, I think he was just premature. With price inflation, such as we have been witnessing for the last several months, that bodes bad for bonds. That is because in the near (another subjective term) interest rates will rise; a killer for bonds.

  • Report this Comment On September 01, 2011, at 2:54 PM, oldengineer wrote:

    Morgan,

    Your statement that "Nonetheless, you can safely anticipate that half of those who attempt to outguess Mr. Market will end up with below-average results."

    Not so - half will end up below the median (not average) results.

    Respectfully,

    OE

    A Morgan Housel fan

  • Report this Comment On September 01, 2011, at 3:18 PM, DANE1969 wrote:

    With all due respect to the experts who post well-

    meant advice, they, and all others who KNOW, will

    be first to admit what will rise, and what will fall,are

    not ----repeat; NOT--- known. Thus, the term: PLAY the market. It is and always has been a crap-shoot.

    The only sure thing---and there aren't many in the market---, is this: If a commodity or a stock is going to be NEEDED for a long time--[oil, tele.com, etc.]

    than it will always stand the test of time= wait-it-out!!

  • Report this Comment On September 05, 2011, at 11:22 PM, Eerkes wrote:

    When Bill Gross sold out of US treasuries, it was an intelligent (in my opinion) long-term thesis, and in effect he was buying other bonds at a relative low, compared to treasuries at a high. At least that is what he pitched it as.

    The fact that treasuries went higher should not change the long-term thesis that he had in the first place.

    His industry does not believe in short-term underperformance, so since he was wrong 6 months after a multi-year call he apologizes and sells low and buys high.

    Poor guy, I sure feel for him.

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