Buy-and-Hold Investing Takes a Lifelong Commitment

I nodded my head in agreement at these comments on buy-and-hold investing from John Hussman (tracked down by Cullen Roche):

Just as day follows night, buy-and-hold strategies reach the peak of their popularity at market tops, because those are the points where every effort in recent memory to sell or reduce risk has apparently failed. Conversely, buy-and-hold strategies are most reviled at bear market troughs, when the full weight of losses is felt. I have no argument at all with investors whose strategy adheres to a disciplined buy-and-hold, diversified across asset classes, over the full market cycle. In contrast, I have great concern about investors who discover buy-and-hold at the top, and adhere to it only long enough to abandon it at the bottom. The most important part of a buy-and-hold discipline is the commitment to remain passive even as it experiences massive interim losses. Look, kid, I never said this was easy. The road to easy street runs through the sewer.

This is exactly right, in my view. The reason so many investors think buy-and-hold investing doesn't work is because they don't have the patience to let it work.

It's also important to point out that buy-and-hold doesn't mean you can buy with abandon at any price. Here's what I wrote a year ago:

The majority of today's investors, who likely began investing during the insane late '90s, have fared [poorly].

But that doesn't prove buy and hold is dead. It just proves that the deluded interpretation of it -- that you can buy stocks any time at any price and still do well -- is wrong. But it was always wrong. It just became easy to forget during the '90s bubble. For as long as people have been investing it's been true that if you pay too much for an asset, you won't do well in the long run. If you buy the S&P 500 at 30 or 40 times earnings, as people did in the late '90s, you're going to fail. If you do like Bill and wait until it's closer to its historic average of 15-20 times earnings (or even better, lower), you'll do all right. Nothing about the last decade has changed that. The '90s, not the 2000s, were the fluke.

A few charts show what I mean.

These three, which I copied last year from statistics blogger Nate Silver, show the correlation between S&P 500 returns and P/E ratios between 1871 and 2011 if held for one year:

It's pretty scattered. There's a lot of randomness. That frustrates investors.

But hold stocks for five years, and the plot gets more organized:

Holding for five year periods, you can have reasonable confidence that buying stocks at good prices will lead to good returns. Randomness doesn't go away, but it diminishes.

Now here's stock returns held for 10 years:

Much less randomness. Buy stocks at good prices, and you should be able to sleep well at night knowing that you'll do well over the subsequent 10 years. There will still be pullbacks and crashes and bear markets. But over time, you'll likely do just fine.

Most investors won't wait 10 years. They get anxious and impatient. That's where Hussman's quote comes in: "Look, kid, I never said this was easy. The road to easy street runs through the sewer."

Remember that the next time the market goes through a slump.

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  • Report this Comment On July 25, 2013, at 1:18 AM, JadedFoolalex wrote:

    "Most investors won't wait 10 years"

    That's cuz these people are NOT investors!! They are "Speculators"!!!

  • Report this Comment On July 26, 2013, at 1:58 PM, sinkstor wrote:

    Patience will be rewarded. My legacy to our grandchildren will be the 8000+ shares of McD accumulated over some 35 years through reinvestment of dividends as well as sporadic purchases at a range of $20 to $70. Now we enjoy the dividends as a nice addition to other retirement income. Would you like fries with that?

  • Report this Comment On July 26, 2013, at 3:54 PM, DavidBressler wrote:

    One way to keep the discipline to hang-in during bear markets, when the perceived losses are felt most, is to focus on a different metric.

    Instead of thinking about the value of the portfolio, focus on the (dividend) income resulting from the portfolio.

    And, even more importantly, if you invest in dividend aristocrats which are VERY LIKELY to increase dividends, even in bear markets, you can focus on the RAISE YOU WILL RECEIVE to that income (which, by the way, often (usually?) beats inflation).

    I have a sample portfolio that highlights these metrics up on Google Docs. In 15 months, the (very simple) portfolio has had a 16% raise in income, and a conservative projected raise over the next 12 months of an additional 13.25%. This is accomplished simply by reinvesting dividends. I explain this blueprint, and share the sample portfolio in great detail at http://ElephantsPaycheck.com in a free 10-part email course (and through a free blog).

    10 years is a short time. If you can think about long-term buy-and-hold like you think about your 30 year home mortgage, that's fantastic. In perspective, if you're 25 and starting to invest towards retirement, you'll probably be working for 50 years (give or take). That's plenty of time for a buy-and-hold strategy to make retirement easy.

    db

  • Report this Comment On July 26, 2013, at 8:25 PM, nberube wrote:

    Great article.

    I would add that simply investing in a home country ETF, a World ETF and a US ETF is the way to go and that way you don't have to worry about the market being overbought or oversold.

    People who worry about volatility can also invest in a Short term bond ETF. The stocks/bonds ratio should follow your age i.e. if you're 30, it should be 30% Bonds ETF and 70% Stocks ETF.

    Add fresh money every month (buy the laggard ETF). Rebalance once a year, and voilà. Over time you will beat 95-99% of money managers on Wall Street.

  • Report this Comment On July 27, 2013, at 12:27 AM, Libertarian71 wrote:

    "Buy-and-hold" appears to be religious tenet to Morgan Housel, and many Motley Fool types. They are constantly bashing technical analysis, because they are not familiar with the art and practice of it.

    A meaningful comparison between buy-and-hold with technical analysis is to compare buy-and-hold results with a simple Trend Following trading system, such as entering the market when it crosses above the 200 day moving average, and exiting when it crosses below that level.

    Ironically, many Motley Fool stock recommendations are of companies showing explosive earnings growth, trading at high price-earnings multiples. These are precisely the kind of stocks that should NOT be held on a buy-and-hold basis, because they tend to get crushed in market downturns. The wiser approach, if you listen to legendary investors such as William O'Neil, who has made a fortune in these stocks, is to buy these stocks as they are emerging from sound base patterns, and only when the market is in a confirmed uptrend. This requires that you look at a chart.

  • Report this Comment On July 27, 2013, at 5:21 PM, nberube wrote:

    RE : KeynesSucks

    Thanks for enlightening us... Have fun timing the market. I'll be outside playing freebee while you look at your charts.

    2 out of 100 money managers will consistently beat the S&P. Good luck!

  • Report this Comment On July 27, 2013, at 10:41 PM, Libertarian71 wrote:

    @nberube

    Who ever said anything about "money managers"? I agree that most of them are horrible, and index funds tend to be better than actively managed ones. It was the religious tenet of "buy-and-hold" that I was commenting on.

    I hope you had fun playing frisbee in the 2000s, because if you were in an S&P index fund on a buy-and-hold basis, you were not making any money. On the other hand, if you had applied a simple entry-exit rule based on the 200 day, you would have avoided the dot com bubble burst and the 2008 financial crisis, and your results would have improved: http://finance.yahoo.com/q/ta?t=my&l=on&z=l&q=l&...

  • Report this Comment On July 28, 2013, at 11:27 AM, Estrogen wrote:

    Current S&P 500 ration is 19.55. According to the 10 yr chart, it will AVERAGE 8% over next 10 years. I think the key has been and often will be to find quality stocks, at a fair price, with a product or service that the market will pay for, with good management, and a moat. Then hold unless your original thesis changes.

    Intellectually, quite easy. Emotionally, most of us humans don't have the patience IMHO.

  • Report this Comment On July 28, 2013, at 5:23 PM, AlexCho wrote:

    Interesting article, outperforming markets with long-term investing can be argued by investing into lower p/e multiple stocks. However the population sample of low p/e stocks are approximately 5,385 (0-15 P/E). So if you average the performance of around 5,385 stocks, the vast majority being small caps. That means that investors should take into consideration the size of these companies.

    However, stocks in the 25 to 100 p/e multiple range is approximately 2,200.

    So if you assume that low p/e multiple = higher returns, that may be a miss representation. Because if we were to average the market capitalization of the 5,385 stocks, you would find that a vast majority of them are smaller companies. So it's not because the P/E ratio is small, it's because there are more small companies that trade at lower P/e ratios than high P/E ratios.

    Basically the principle is that small companies are usually able to appreciate at higher rates. The low p/e multiple comes from the fact, that investors are willing to pay lower multiples for higher risk investments.

    Earlier I saw an argument that McDonald's was a great value investment. However, the company's average earnings multiple on a ttm basis was 16.6 over the past 5-years. The company's average earnings growth is 4% historically. So there's no way to justify the investment on the basis of low multiples = high returns. It never traded at a low P/E multiple, and it never grew at high rates in terms of earnings.

    Yet the stock seems to have appreciated by 67%. Obviously, if low multiples were the only reason for investment returns. Why is it that low-growth stocks, with high multiples, are able to appreciate.

    Also, I don't understand how the author was able to determine the P/E multiple, and earnings growth on a chart with just two axis. Here's the problem, the P/E multiple is a constantly fluctuation indicator. Sometimes, a low P/E multiple stocks becomes a higher P/E multiple, before dropping to a low P/E multiple.

    The price component of a stock, can fluctuate a lot without fundamentals being taken into consideration. This chart is in fact trying to measure price, earnings, and returns. The returns however is the sketchy part, because you can't tell based on the data, whether the returns came from the fact that the stock was cheap relative to its potential. This usually only happens when a stock market crashes. Yeah, at some point stock traded below a 10 earnings mutliple, because the price of stock were cheap relative to future potential.

    However, if you were to average the return 10-years out when stocks were trading at below average multiples. Wasn't it just the fact that markets were irrational, and traded at low valuations. Then doesn't mean that this strategy of low P/Es tends to work better in a cyclical market bottom.

    And isn't it almost impossible to know when a market bottoms? Isn't it also impractical to think that low P/E stocks can generate alpha, returns above risk. When.... everything is trading at premium relative to earnings right now. Is the low P/E multiple strategy the most appropriate right now? Will it generate the highest returns, when you take into consideration the fact that the chart depicts that when P/E mutliples are cheap the next 10-years in terms of appreciation are exceedingly good. This chart seems to reflect the performance of stocks when you buy them near a market bottom, rather than coming across as a practical investment strategy for long-term investors.

  • Report this Comment On July 28, 2013, at 7:41 PM, Ecotone wrote:

    It would be more useful to show the graphs with more appropriate axes. The 10-year returns are crunched between 20% and ~ -5%. Just spread that out, and it is easier to see visually the negative correlation between PE and average annual return. You could also go further and show the R2 value (take the correlation test statistic R and square it. This value would then tell you how much variation in average annual return is explained by PE.

  • Report this Comment On July 28, 2013, at 9:21 PM, SkepikI wrote:

    Wow: Morgan another winner. if not in the content (which I agree is pretty good) then CERTAINLY in the valuable info in the commentary. to all of you who think making only 1% more or only a bit less than the market is the depths of depression, I say I will take 7% return averaged over 10 years or even 5% over 10 years as long as inflation is 3% or less. I might even take it if inflation is more as long as I can claw back in 4 or 5 years and fish and drink my last few years away.... What I cant or wont take is binging all in at the top only to panic at the bottom and create permanent capital impairment of 10 or 20% at my current age of 62. A losing proposition. Or to steal a turn of phrase from Hussman - a run through the sewer...

  • Report this Comment On July 29, 2013, at 12:15 AM, TelsaRowe wrote:

    Whats happened in the past market does not mean it will happen in the future. With the rise of HFT trading and globalization of markets buy and hold could end disastrously. Worst of all, buying and holding for 10 years only to see your profits vanish in months to a year could could your life quite literally.

    Forget buying and holding, dont bet your life, your familys life and retirement on it. It will backfire. Buy stocks on market crashes, sell the stocks and hold the cash. Thats the only buying and holding one should be doing.

  • Report this Comment On July 29, 2013, at 1:01 PM, foolishlymeek wrote:

    Thank you, Morgan, for an extremely interesting article that generated great comments!

    I'm definitely learning about investing as I go. I buy and hold - and hold! I find it much more difficult to sell a stock than to buy a stock. I've seen some of my stocks - such as Nokia - go from great investments to a huge losses. (I'm just hoping NOK's newest phone will bring me back to break-even!)

    I did, however, make some great investments in 2008-2009 when I bought stocks while "blood ran through the streets" (to paraphrase Warren Buffet).

    I could not tell you what kind of investor I am. I buy and hold (and seldom sell); love re-investing dividends to get continued returns from my stocks (and take advantage of dollar-cost averaging); try to find stocks on sale during the "dips"; and look for good companies that are re-inventing the wheel - such as Stratasys.

    However, I am enjoying watching my stock investments go up in value a lot faster than my savings account - which current earns 1/10 of 1 percent!

    Donna

  • Report this Comment On July 29, 2013, at 1:40 PM, TheDumbMoney wrote:

    The great object lesson here is that, ironically, John Hussman is not really a buy-and-hold investor at all, to the best of my knowledge. He is actually one of the "hedgiest" of all mutual fund managers. And his constant hedging since 2009 has demolished a significant portion of his previously-stellar reputation. This activity has been based on a view of the Fed colored by flawed ideology (even though he is clearly smarter than I am). He even stepped outside of his expertise and started writing pieces about how the Fed's actions were illegal. And his recent troubles were based on him originally using an insufficient dataset for his obsessive macro modeling -- i.e., he goes WAY beyond just looking at individual company earnings.

    So Hussman is a good lesson that even if you know the right thing to do, professional and ideological pressures can prevent you from doing it. Like most ideologues though, he would never admit that he is one. And in all other respects he is a wonderful investor and I'm sure is a wonderful person.

    Berkowitz is a much better example of a mutual fund manager who actually walks the walk of being a buy-and-hold investor. There's a guy who does not mess with macro stuff, does not do hedging, after winning Morningstar manager of the decade from 2000-2010, buys skads of BofA and AIG in I think early 2010, then watches his fund nearly implode in 2011 because of his huge early bets on BofA and AIG, but says "bring it on!", buys more, and whose fund then is if I recall the number one fund of 2012 and doing well in 2013 too.

  • Report this Comment On July 29, 2013, at 4:34 PM, HectorLemans wrote:

    Two tricks I've learned that help immensely when trying to stick to a buy-and-hold strategy: 1) Always leave some cash on the sideline and 2) Always try to be invested in at least 3 or 4 different asset classes. What I mean by that is don't go all-in on REIT's (burned by the financial panic) or tech companies (burned by the dot-com bubble) or commodities (burned every other year it seems like). You will get burned, but it's much easier to stay on the ship when only a part of it is burning rather than the whole thing. Always having some cash helps when markets are falling and everyone is panicking - every time you get the urge to sell, just remember that's the best time to buy and purchase some stocks that Mr. Market is discounting. More of a psychological thing than anything.

  • Report this Comment On July 30, 2013, at 7:13 AM, CraigWPowell wrote:

    I am not BUY and Hold investor.

    What to buy and hold?

    May be ALU,

    Alcatel is up +8.53% today and more than 100% this year, in a good agreement with this article published on Seeking Alpha: http://seekingalpha.com/article/1561202-fundamental-strength...

  • Report this Comment On July 31, 2013, at 9:42 AM, Mathman6577 wrote:

    Buy and hold works. I've owned shares of UTX and a SP500 index fund for over 30 years. That and owning other solid companies like WMT, MCD, KO, IBM, PG and JNJ will get you rich over the long term. No short term get rich quick schemes.

  • Report this Comment On August 01, 2013, at 1:03 PM, nberube wrote:

    @KeynesSucks

    Every day the market is down, I'm happy. Every day the market is up, I'm pissed. The last 10 years have been a fantastic time to accumulate stocks...

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