Should We Finally Bury Buy and Hold?

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 (NYSE: 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 (NYSE: WMT  ) with a forward price-to-earnings ratio of 11.1, Intel (Nasdaq: INTC  ) with a P/E of 8.7, and Aflac (NYSE: 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 (NYSE: 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."

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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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 September 19, 2011, at 12:33 PM, athebob wrote:

    To put it properly, as an investor you are not trying to time the market, but to price the market.

  • Report this Comment On September 19, 2011, at 1:10 PM, SteelThumb wrote:

    "Reasonable price tag" and "worth" still have elements of timing. Consider the frequent comments about stock P/E, price/book or price/div being cheap or expensive. Over what time frame? Going back 100 years stocks may look expensive, over 15 years, cheap, over 5 years they may have an average valuation. Another consideration is that big market moves take time to get investors, managers and analysts on the wagon and aligned in their emotions. This again can produce a timing aspect where we hear that "the average return over the last X years is Y%. "X" changes with marketing tactics and investor emotions.

  • Report this Comment On September 19, 2011, at 1:49 PM, 123spot wrote:

    Thank you. Each article like this adds further clarification to my investing strategy. Spot

  • Report this Comment On September 19, 2011, at 2:08 PM, athebob wrote:

    First off, I mis-typed, and I must say I work fro the bottom, so I really meant price a company, not the market(it is hard enough to do for one company, let alone an industry, or whole economy.

    Yes there is uncertainty(intrinsic value is a very rough estimate), that is why you must look for large discrepancies. And, yes the time range is very uncertain, and is why many deep value investors wait until some type of catalyst appears to help the market realize underlying value.

    That said, I am not looking if a company looks cheap relative to its past, I am looking for either a huge discount to private value of assets for a company where future operations are not worth much, or to get a fair price on a company that will be able to continually increase value through its ongoing operations(a fair price to me being one that allows a satisfactory return under the expected future circumstances).

    So the biggest problem is estimating the future, and this is where it is clutch to have a skill that many people lack, that many people aren't even aware they lack; that is the ability to admit the answer is, "I don't know."

  • Report this Comment On September 19, 2011, at 3:31 PM, dbtheonly wrote:

    Well James,

    I do not advocate "one-night-stands" for either women or stocks.

    For stocks, there is nothing wrong with buying on dips & I don't see that it violates the basic buy & hold strategy. The trick is not to panic. As an example I added to MCD on the recent earnings miss. I got in at $85.90. The stock dropped to $84 that day. I felt foolish, but believing that one can never call the absolute bottom, I was satisfied. I'm more satisfied now at $88.40.

    The short version is that one can not predict whether the next tick will be up or down. We can research, analyze, but in the end we have to ahve enough faith in our own judgment to take the shot.

  • Report this Comment On September 19, 2011, at 4:15 PM, yezaq wrote:

    It seems that we hear this buy and hold argument way to much. It's alive one week and then dead the next. You don't need to many great companies to make a ton of money. Most of the time they are staring you right in the face. Great history, great growth prospects and a good price. To me falling share prices are great opportunites. Thats why I don't div reinvest. I want all divs plus added money in order to double down on a stock that typically moves down for no reason of their own.

  • Report this Comment On September 19, 2011, at 7:49 PM, memoandstitch wrote:

    Wow, TV dinners date back to 1962?

    Now they should be called youtube dinner or LEDTV dinner lol.

  • Report this Comment On September 20, 2011, at 2:33 PM, daveandrae wrote:

    My investment portfolio's September 20th, 2011 year over year performance data.

    Asset Allocation-

    100% equity

    Turnover ratio-

    Negligible

    Holdings-

    Harley Davidson - 33.29%

    McDonald's - 24.03%

    Pfizer - 10.18%

    Dow Chemical - 3.94%

    General Electric - 1.62%

    Total Aggregate Return-

    14.61%

    S&P 500-

    8.12%

    Does buy and hold investing "work?"

    Of course it does.

    The problem, from where I stand is two fold.

    1. The statistical truth, which is also the great moral LIE in this business is that investment performance, is synonymous with Investor Return. As you can clearly see, there is absolutely, positively NO correlation here whatsoever.

    2. The great driver behind Total Return, is not "investment performance", but rather Investor Behavior. Put another way, the only thing you have ANY control over, your own behavior, is also the overwhelming variable driving your total rate of return. Thus, it really doesn't matter that my investments are "outperforming" the market.

    That which matters most, is that I am "outperforming" all of YOU!

    This is the beginning of wisdom.

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