Sep 10, 2014 Investment Education: Long term buy-and-hold strategies are not right for everyone
Investment Education: Long term buy-and-hold strategies are not right for everyone.
In the Sept 6 edition of the Wall Street Journal. Writer Brett Arends presents the case for long term investors “sticking with Stocks – no matter the price” . The essence of his article is that over the long term, stocks outperform bonds and cash. While this latter statement is historically true, it is simplistic, and I do not agree that one should therefore keep 60% invested in stocks, as a quote in his article suggests.
First, as an investment professional, I have lived through 6 or so major investment cycles, depending on how you measure. In each cycle, when stocks were at a high valuation point, this suggestion that long term investors stay invested with some specified percent of their portfolio comes up. I would even argue that the timing of such articles is itself a sign that we may be near a market top.
But does the stock market’s long term return data really justify staying in for most people? Here are some observations.
First, how many people can really allow a lot of their savings to be committed to a long term buy and hold plan? Young people saving for a down payment on a home, or other major purchase may well need the money at exactly the point where the stock market is at a low. In the depths of the 2008 bear market, a lot 20- and 30-somethings had their saving wiped out or substantially reduced. Cars and then-cheap houses could not be paid for with money lost in the market. Many parents paying for their kids college education suddenly had a financial crisis. I know many retirees or near retirees who made major life style changes because their stock market nest egg was substantially reduced.
In fact, when the market is lowest, is when you would ideally want to put more money into stocks. But it is exactly that time when the economy and investment environment are the bleakest and a recovery cannot be taken for granted. When your savings has fallen below some level, and recovery is not assured, and your lifestyle, present or future, is threatened, it may be a perfectly rational decision to cut way back on your stock investments, even though history suggest stocks will recover. It is also important to note here, that many stocks never recovery. Many an investor in the wrong stocks or mutual funds has not participated meaningfully in this recovery.
The Wall Street Journal article does say that those with shorter-term investment horizons, or who cannot handle too much risk, should hold a much smaller portion of their money in stocks. That I agree with, although I do not have a recommendation as to how much to hold. But here are some things to consider:
1. When stock market valuations are high by many metrics, lighten up on some of your holding. Yes, overvalued markets can and do become more overvalued, but very few people are good at picking the exact top, and no one ever went broke taking profits, to quote an old market saw.
2. Do put a small portion of your investable funds into stocks on a long term passive basis, as the article suggests, but…
3. Have a short or intermediate term active account. Whether you buy and sell mutual funds or individual stocks, or both in your own account, watching these investments daily in the context of political, economic, and stock market news will be a valuable investment education and help teach you to make judgments about when to increase or decrease your exposure to stocks. You are not going to be right all the time, but with experience, your judgment should improve, and you will add value to your portfolio.
One other point in the WSJ article deserves comment. The writer suggests that larger, higher quality blue chip companies entail lower risk than smaller and more speculative growth companies. Of course that depends on how you define or select your smaller and more speculative companies. But I suggest that many so called blue-chip companies are beyond their rapid growth years and as such, their stock price will underperform the market. For one extreme example, note that photography company Eastman Kodak was considered a blue chip for many years, but from the late 1990’s it declined more or less steadily and eventually declared bankruptcy in 2012.
If you are looking for a passive, buy and hold stock index, I have had much better performance with mid cap indexes than with large cap, so-called blue chip indexes. My favorite is MDY, which is the S&P Midcap 400 ETF.
To view an excerpt from our new book, “Why Stocks Go Up and Down, 4th Edition”, CLICK HERE
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