Buy-and-Hold works after the passage of 30 years.
I’ve said that before and I stand by the comment because there is a sense in which it is so. However, there is also a sense in which it is NOT so. The purpose of this article is to present both sides of the story.
Buy-and-hold’s Finest Hour
Buy-and-Hold is popular today because we are living in the wake of the biggest bull market in history. It’s not only Buy-and-Hold that works in bull markets. Any strategy that calls for a high stock allocation works in a bull market. But Buy-and-Hold was being pushed heavily during the bull years and lots of people adopted the strategy and made lots of money. That made the strategy popular. It certainly is fair to say that Buy-and-Hold delivers the goods for so long as stock prices are headed upward.
Buy-and-Hold performs poorly in secular bear markets. Investors who follow this strategy end up giving back most of their gains when prices go through the crashes they need to go through to return to fair-value levels. Stocks were priced at three times fair value in 2000. They always end up at one-half of fair value in the bear market that follows a bull. So investors who had $600,000 at the top of the bull should expect to end up having something in the neighborhood of $100,000 remaining at the end of this secular bear market (going from 3x to 0.5x is a loss of five-sixths of one’s accumulated life savings).
When bull markets become bear markets
Buy-and-Holders often note that, just as bull markets produce bear markets, bear markers produce bull markets. Once prices work their way down to one-half fair value, they will begin moving up to fair-value levels again. So the Buy-and-Holders will end up with a portfolio value not of 0.5x but of 1.0x. And the “x” will have grown much larger over the course of years in which valuations were rising and falling and rising again. Stocks produce an annual return of 6.5 percent real during times when valuations remain steady. So an investor who obtains a portfolio value of 1.0x over a long period of time is earning a very nice long-term return by doing so.
The Stock-Return Predictor tells the story.
When stocks are priced as they were in 1982 (one-half fair value), the most likely annualized 10-year return is 15 percent real. When stocks are priced as they were in 2000 (three times fair value), the most likely annualized 30-year return is a negative 1 percent real.
Multiply your returns by buying smart
But look how things change when we examine 30-year returns. The most likely annualized 30-year return when stocks are priced as they were in 1982 is 11 percent real. The most likely annualized 30-year return when stocks are priced as they were in 2000 is 5 percent real. The former return is more than double the latter return. But the latter return is not at all bad. You won’t get a 5 percent return investing in Certificates of Deposit. So can it be said that Buy-and-Hold “works” in the super long-term?
I think it would be fair to say that so long as two caveats are included.
One, you only get that 5 percent return at the end of 30 years if you refrain from selling any stocks during the time-period when your you are seeing five sixths of the accumulated wealth of a lifetime disappear into thin air. Can you do it? Can anyone do it?
I have my doubts. I just don’t think that humans are capable of taking that sort of hit. My guess is that fewer than one in ten Buy-and-Holders ends up sticking with his high stock allocations through an entire bull/bear cycle. So I view it as irresponsible for so many of the “experts” in this field to endorse Buy-and-Hold strategies.
Still, the numbers say what the numbers say. If you only look at the numbers, and ignore the question of whether it is possible for most investors to do what it takes for Buy-and-Hold to pay off in the long run, Buy-and-Hold can be said to “work” at the end of 30 years regardless of the valuation level that applies at the beginning of the 30 years.
Valuation-informed-indexing works even better
Even then, however, Buy-and-Hold does not work nearly as well as Valuation-Informed Indexing. The Valuation-Informed Indexer never sees the huge portfolio drawdowns that the Buy-and-Holders see. So he never faces strong temptations to lower his stock allocation at the wrong time. Then, at the end of 30 years, when the Buy-and-Holder finally sees good numbers, he still is trounced by the Valuation-Informed Indexer. A 5 percent return over 30 years is good. An 11 percent return over 30 years is a lot better.
The comparison I am drawing here is an extreme one. The valuation level we saw in 1982 is one of the lowest we have ever seen. The valuation level we saw in 2000 is the highest we have ever seen. It is not normally the case that the benefit of switching to a Valuation-Informed Indexing strategy is so great. For example, the most likely 30-year annualized return for stocks purchased at fair-value prices is 7 percent real. That’s better than the 5 percent real that applied for stocks purchased at the market top. But the two numbers are at least in the same general neighborhood.
That said, it’s important to consider how big a difference two percentage points of return makes when you are talking about a 30-year annualized return. Getting an extra two percentage points of return for a year or two is not that big a deal. Getting an extra two percentage points of return in every year for 30 years running is huge. You get decades of compounding returns on all those extra payoffs. The differential in the dollar values of the two portfolios ends up being very large indeed.
It can be argued that Buy-and-Hold more or less “works” at the conclusion of 30 years. But Valuation-Informed Indexing still works a lot better, both emotionally and financially. Even when Buy-and-Hold produces results that are not as awful as those it often produces at the 10-year and 20-year markets, it is the far inferior strategy.