LISTEN: mp3 audio (9:07 min)
Buy-and-hold: an accumulation strategy based on the belief that even though there will be intermittent periods
of volatility and decline, profitable rates of return will be realized by those who keep their money invested in the financial markets over long periods of time.
The buy-and-hold approach is often recommended for œretail investors, (i.e., those who aren’t professional money managers, but place their money with financial institutions through brokers or other financial representatives) because buy-and-hold doesn’t require nonprofessionals to engage in regular market timing (trying to buy on lows and sell on highs), thus minimizing both mistakes and expenses.
There is considerable historical evidence that buy-and-hold is profitable over longer time periods, particularly 20 years or more. And prior to last year’s steep decline in market values, most shorter-term buy-and-hold periods for the past three decades showed good results as well.
But the statistical evidence supporting buy-and-hold doesn’t translate to the real world, primarily because retail investors don’t hold what they buy.
For the past 15 years DALBAR, a research company based in Boston, MA, has issued an annual report titled Quantitative Analysis of Investor Behavior (QAIB), which measures the œeffects of investor decisions to buy, sell, and switch into and out of mutual funds. Here’s an excerpt from the 2009 report:
Throughout the 15-year history of QAIB, which encompassed periods of unprecedented market upswings as well as last year’s drop, the œaverage investor has continuously achieved 20-year results that have lagged what the oft-quoted return statistics would lead investors to believe are achievable. Why? There is one simple reason: When the going gets tough, investors panic.
According to DALBAR’s research, the average mutual fund shareholder stays invested for 4-5 years during good times, and as little as 2½ years during down stretches. Consequently, investors never realize 20-year profits because they never stay in the market that long. In addition, most retail investors enter or exit the market at the wrong time “ they buy high and sell low. According to DALBAR’s research, this is not a recent phenomenon; average investors have never bought-and-held for long periods, and have always achieved real returns well below the statistical possibilities.
Combine this behavior pattern with the precipitous decline in values over the past 18 months and the result is a strong backlash against buy-and-hold as a legitimate accumulation strategy. Type the phrase œthe end of buy-and-hold investing in a search engine, and the results are astounding. Some recent headlines, from prominent sources:
An End to Buy-and-Hold Stock Investing?
(CBS News EconWatch, March 9, 2009)More Investors Say Bye-Bye to Buy-and-Hold (Wall Street Journal, April 8, 2009)
Buy-and-Hold in Disrepute
(Forbes, April 18, 2009)
Most of the commentary in the articles confirms DALBAR’s findings: Things are tough, and investors are in panic mode. In some cases, there is a sense of betrayal conveyed by investors. They were told values might drop, but never expected the fall could be this steep, and the time it will take to recover the losses seems too long. In the WSJ article, 31-year-old Kenneth Kimmons described why he stopped making regular deposits to his 401(k): œI just got tired of putting money away and losing it.
But if buy-and-hold dies out as a popular strategy for retail investors (read: the average American saver), is it really a bad thing? Maybe not.
Buy-and-hold was touted as a set-it-and-forget-it financial approach. It was passive. You simply provided the money, let the markets do their magic, and œPresto! 30 years later, you can retire! The WSJ article referenced above mentions that the recent losses resulting from the passive approach has prompted many savers to take a more active and responsible approach to managing their money. As Robert Lenzner says in the Forbes article, œInvestors beware: You have to watch over your money like hawks, read your monthly statements and ask questions. You must be active, not passive¦
For some retail investors, this active approach means a move toward more conservative financial products that accurately reflect their true risk tolerance “ so they don’t have to watch over their money like a hawk, or read monthly statements. For example, some insurance companies reported a 60% increase in sales of fixed annuities over the past year.*
For others, a more active approach means exercising direct control over their investment decisions. Instead of letting someone else manage their money, the individual is taking all the responsibility. The WSJ article reports that discount brokerage companies are œseeing record levels of trading activity and new-account openings.
“Typically in a bear market, you’ll see a retraction of activity and reduction of people opening new accounts,” says Jay Pestrichelli, managing director at TD Ameritrade. “This time around, somebody forgot to tell the retail client that’s what happens.”
Not everyone is convinced that retail investors will find results from personal management better than what they experienced with buy-and-hold. John Bogle, the 79-year-old founder of mutual fund giant Vanguard Group, who helped popularize index funds and promoted the idea that individual investing is œa fools’ game said, “If you want to trade the market, you’ve got to be right twice — you’ve got to get out and get back in. Not only is there the question of whether individuals are savvy enough to manage their own money, but active short-term investors typically pay more commissions, fees and other costs. And various studies have shown that most market timers typically lose more money than buy-and-hold investors.
Perhaps what’s happened is retail investment clients are beginning to understand the true risks associated with investments in the financial markets. As Declan McCullagh commented in the CBSNews article, œFinancial planners and writers love to assure skittish investors that, no matter how bad the stock market looks right now, share prices always go up by 10 percent or so in the long run. Now they are beginning to understand how long the long run can be, and they aren’t sure they want to hold on for the entire ride, especially if it includes some steep declines.
*www.InvestmentNews.com, March 6, 2009: Fixed-Annuities Sales Rose 60% in 2008. Sales of fixed annuity climbed to $107 billion last year up 60% from 2007, according to the Beacon Research Fixed Annuity Premium Study.
