What about the value of 'Buy and Hold'...??
'Buy-and-hold' stock strategy may be outdated, analysts say
By David A. Sylvester
The Mercury News
May. 02, 2002
siliconvalley.com
During the past 20 years, one style of investing in the stock market has become such a sacred dogma that you probably know the litany by heart:
Buy stocks for the long-term, invest in a stock index fund, and hold the investment through ups and downs. Most of all, don't worry, because stocks always beat other investments, like bonds or cash, over many years.
Since the beginning of the bull market in 1982, this approach has been something of a financial miracle. There's nothing like a 650 percent rise in the Standard & Poor's 500 over two decades to convince the average investor that he or she will do best by investing broadly in the market.
There's only one problem: The buy and hold approach hasn't worked for two years.
Stock market index funds have plunged sharply and are down again so far this year. Bonds have far outperformed stocks, and even lowly money funds -- those that invest in short-term Treasury bills -- have produced a positive real return.
What's going on?
``This is a trader's market, not an investor's market,'' said Toni Turner, author and president of TrendStar Trading Group.
In fact, a growing number of stock market professionals are starting to question whether the buy-and-hold approach will work for a market that looks more like the see-saw trading market of the 1970s. If true, this could have a profound impact on the millions of new investors who entered the stock market during the bull market. It could force them to revise their financial plans for everything from their children's college educations to their own retirement and financial security.
Old thinking challenged
Jim Paulsen, chief investment officer for Wells Capital Management, has noticed the shift in thinking and predicts investors will need to change their approach to make a profit from stocks in the new market. In April, Paulsen devoted his entire economic newsletter to the change.
``The buy-and-hold mantra which has come to dominate the investment culture is being significantly challenged,'' he noted.
It's premature to cast aside the ``buy-and-hold'' strategy entirely, Paulsen thinks, but large institutional investors are more concerned about their low returns on stocks recently. Pension funds, for instance, calculate their payments to retirees based on stock market returns -- if those fall below expected levels, the funds start searching for ways to make up the difference.
And some of those ways revive the old techniques of ``market timing,'' the ability to buy and sell stocks based on a forecast of where prices are headed. Such an approach became popular during the up and down market from 1966 to 1982 when the Dow Jones industrials fluctuated between 700 and 1,000.
``When I started in this business in 1982, all the wisdom of Wall Street was about market timing,'' Paulsen said. ``No one was suggesting the way to make money was to buy and hold.''
To make money, successful investors had to adopt completely different rules from the buy-and-hold approach. They sold during the rallies, tried to guess the correct timing for entering and leaving stocks and chose stocks from the right industry sector -- all of which requires considerable sophistication and effort.
Buy-and-hold adherents maintain that history shows such active trading produces worse results than just riding with the index. According to research provided by the Vanguard Group, even during last year's bad market, 61 percent of the mutual funds holding large capitalized stocks lost even more than the S&P 500.
Brad Barber and Terence O'Dean, two finance professors at UC-Davis, studied the returns from actively managed funds compared to the S&P index from 1991 through 1996 and found the managed funds did worse as a whole than the index. Using data going back to 1962, they found actively managed funds had an average annual return of 12.4 percent, compared to 14 percent for the S&P 500.
``Basically when you trade, you're betting against other market participants,'' said Barber.
However, this data does show some periods when active funds did better than the index -- between 1976 and 1982 and between 1965 and 1968.
Buy-and-hold `a cop-out'
For their part, traders say the buy and hold approach is a simplistic formula marketed by the mutual fund industry.
``It's a cop-out,'' said Chris A. Farrell, president of the Farrell Preferred Stock Arbitrage hedge fund. ``People think that buy-and-hold is buy-and-ignore-it. Managing your money is like a job, and the market doesn't give money away. It takes time and effort.''
It is true that academic research supports the ``buy and hold'' approach over long stretches of time, like 20 years or more. Theoretically, investors would do well if they wait out market droughts like the one stretching from the late 1960s to the start of the bull market in 1982.
The problem, according to David Rahn, president of Avalon Capital in Port of Redwood City, is that few people behave like the mathematical model. ``It's a great argument, but it's not practical because no one can do it,'' he says.
He, too, remembers the 1970s and found many investors left the market entirely after suffering through 16 years of no gains.
``By 1981, you couldn't convince anyone to invest in stocks,'' he remembers.
There are plenty of signs this stock market has changed. The Standard & Poor's 500 is down 6 percent since the beginning of this year, meaning it has to rise more than this by the end of the year to avoid having a third losing year in a row. The last time that the S&P 500 declined three years in a row was during World War II, and before that, during the Great Depression.
With its recent decline, the market has now lost four years of its bull market gains. In fact, more time has now passed since the S&P hit a new high than at any point since the bull markets began in 1982.
Right now, among the S&P 500 stocks, the biggest and strongest American corporations, half are trading at the same prices of 1997, producing five years of no gain.
And that's why some may start looking for other ways to invest. Paulsen believes the stock market is like the 1970s trading market, but for different economic reasons. Instead of high inflation and rising interest rates, the economy is experiencing low inflation and declining interest rates.
This could keep corporate profits -- and stock prices -- from rising very much. In this world, investors might do better to invest in long-term, high quality bonds, international stocks that could rise as the dollar weakens and stocks that pay dividends to improve their yields.
No matter what, this new world of investing is not likely to be pay investors quite like he booming markets of the late 1990s. ``There's nothing to replace a bull market in terms of absolute returns,'' said Paulsen. |
