What?s So Bad About Buy-and-Hold?

Beyond Buy-and-Hold #30

I bill myself as the most severe critic of Buy-and-Hold Investing alive on Planet Earth today. I say that it is likely going to cause millions of failed retirements. I say that it was the primary cause of the economic crisis. I say that it cancels out the effect of teeth whiteners.

Well, maybe not that last one. But if there?s something bad and scary going on in the world, there?s a good chance that Rob Bennett has attributed it to the popularity of Buy-and-Hold Investing.

This angers some and mystifies many. What?s the story? Why have I made this my obsession? What can?t I just let it go? What has Buy-and-Hold ever done to me?

When an investment strategy looks too perfect watch out!

The trouble is that Buy-and-Hold comes so tantalizingly close to being the perfect investing strategy that it has taken in millions of smart and good people. These people are my friends. I could learn lots of good stuff from these people if we could engage in civil and reasoned discussions of realistic investment strategies. But their belief in Buy-and-Hold makes that impossible.

The differences between Buy-and-Hold and Valuation-Informed Indexing (the strategy I favor) are so fundamental that the two strategies lead to entirely different places on just about every question that comes up. It would be fair to say that Valuation-Informed Indexing is the opposite of Buy-and-Hold.

What?s so bad about Buy-and-Hold?

Warren Buffett follows it, doesn?t he?


Warren Buffett does not follow Buy-and-Hold.

Warren Buffett does it right. Warren Buffett?s strategy is the opposite of Buy-and-Hold.

Warren Buffett follows a two-step approach: (1) he researches and researches and researches until he finds a strong value proposition; and (2) he sticks with his decision long enough for it to pay off.

Step Two is essential. The thing that makes stock investing tricky is that what works in the short term is often not what works in the long term. Buffett doesn?t permit himself to be fooled by the short-term noise. If he identifies a good stock and invests in it and it does poorly for some time, he doesn?t let that phase him. He sticks with his choice. He holds. More often than not, his choice pays off in the long run.

All that makes sense. Buy-and-Holders incorporate this element of Buffett?s genius into their strategy. That?s great. It?s because Buy-and-Holders know to stick with their choices for the long run that Buy-and-Hold offers such promise. It is this element of the strategy that pulls in so many smart people.

The forgotten Step Two of the investment world

But Step One of the two-step Buffett process is also essential.

Yes, you want to stick with your investing choices for the long run. That?s critical. But you must make good choices for this strategy to pay off. You don?t want to stick with bad choices! Sticking with bad choices will ruin you. Sticking with bad choices is the anti-Buffett approach. Sticking with bad choices is dumb and dangerous.

Why would anyone want to stick with a bad choice? Why? Why? Why?

Most Buy-and-Holders don?t pick individual stocks, like Buffett. They are indexers. That?s fine. Most middle-class investors don?t have the time to do the sort of research that Buffett does. Indexing is a great choice for the vast majority of investors.

But picking indexes doesn?t free you of the need to identify strong value propositions and to refuse to put money on the table until you find one. What make the ?hold? part of Buy-and-Hold work is that it takes time for strong value propositions to pay off. Guess what happens in the long term to poor value propositions? They reveal themselves as poor value propositions, just as surely as strong value propositions reveal themselves over time as strong value propositions.

Fail to limit your investing to strong value propositions and you take the magic of long-term investing and turn it against you. There?s a chance that a poor value proposition will pay off in the short-term. There?s almost no chance that it will pay off in the long term. Invest your money in a poor value proposition as a Buy-and-Holder and you lock in a loss by sticking with that choice for the long term.

Indexers need to direct their investing dollars to strong value propositions every bit as much as stock pickers. Stock pickers do it by identifying good companies. Indexers do it by going with high stock allocations only when stocks are low or moderately priced. Buy-and-Hold cannot work because it doesn?t call for the investor to change his stock allocation in response to price changes and thus often leaves the investor holding to an investment choice that he should not have made in the first place.

Rob Bennett admires John Bogle but believes that he made a big mistake with his endorsement of Buy-and-Hold. His bio is here.

9 Responses to What?s So Bad About Buy-and-Hold?

  1. Rob – You’re raising some good points. But the real issue may be inertia – nobody wants to move from an investment method that’s so fuzzy and warm!

    The basic appeal of buy-and-hold – apart from the fact that it’s so entrenched – is the appeal of wealth without effort. The basic premise is that you pony up your money, buy your investments, and get your 6.5% annual return for the rest of your life. Then sit back, and wait until retirement when you can live off the fat of the land.

    Now in the real world, this is a complete fantasy, but as the saying goes, “it’s not the truth, but what the people believe that counts”.

    When change does come – and I think it will – it probably will come from external pressue, like a 3rd crash. When people are in a rut it takes an unusual counter force to move them out of it, even if the rut isn’t working.

  2. I’m not sure that I agree that the appeal of Buy-and-Hold is wealth without effort, Kevin. It’s promoted as an anti-Get Rich Quick approach.

    It really does not take hardly any effort to earn that 6.5 percent real return. Valuation-Informed Indexers earn that and they don’t put in any effort. We get that return just because our economy is sufficiently productive to permit that sort of return for those with money to put into stocks. It’s the proverbial free lunch. Some things in life just come easy. When we come across something that’s easy, we should just enjoy it and not ask too many questions.

    I think that the reason why people have a hard time moving from Buy-and-Hold to Valuation-Informed Indexing is that it seems too good to be true. VII says that we can predict stock returns. Risk is uncertainty. Something predictable is not uncertain. So, when we move to VII, we are greatly reducing the risk of stock investing. Stocks have always been risky and this just sounds like too much good news.

    The reality is that humans really do learn new things over time. We learned how to harness electricity. We learned how to develop immunizations for many diseases. We learn how to make computers tablet-sized. This is a case of a huge innovation (I am not saying that I am responsible for it, I am just a reporter reporting on all the exciting developments) that people are having a hard time taking in because it is such a big advance all at once.

    Buy-and-Hold was a huge advance too in its time. I am going to have a future column that will list about 10 big insights that we learned about from development of the Buy-and-Hold Model. The only problem with Buy-and-Hold is that they didn’t get it perfect on the first go-around and of course it’s not fair to expect that.

    What’s going on here is that we have been making huge advances in our understanding of stock investing over the past 50 years after hundreds of years when things pretty much went around in circles. The reason that is happening is that the study of investing became an academic/scientific enterprise in the 1960s for the first time. We should have anticipated a number of huge steps forward. But, as with the computer and the immunizations and electricity, once we started making progress, we moved ahead at a much faster pace than any of us could have imagined.

    This is all good news. The trouble is that it is too much good news all at once. People just have to accept that truly wonderful things do happen from time to time in this mixed-up world of ours.

    I agree that the next crash is likely to be the thing that overcomes the inertia. I very much wish that it didn’t need to be that way. But there is a lot of evidence that that is the way this is going to play out. It takes humility for us to admit mistakes and move forward and it takes pain for us to be willing to become humble. That’s the dark side of all this. Humans!


  3. I’m not an investor, but I have purchased stocks in a few companies in the past. My biggest was in an internet startup back in the dot com days. They provided wholesale VoIP. It was the next big thing, and they were a leader. I was able to get in on the IPO and my intention from the start was to buy and hold. I believed in the technology and in the firm. Within a year my investment was worth more then 10 times my investment. It then preceded to fall, and fall, and fall. I didn’t sell. I was then faced with the mind set that I was loosing money. It was hard to get over selling at 8, 7, 6, 3 times my investment, when it was at 10 times. I eventually sold at a significant loss, and spent years pondering, “what the heck was I thinking!”. I wished I had the insights you have shared, back then.

  4. Thanks much for stopping by, Norm.

    The tricky thing is that a strong long-term value proposition can do very poorly in the short term and a poor long-term value proposition can do very well in the short term. Sticking with your choices makes sense when you are really sure that the choices are good ones. But you need to be really, really sure.

    With index funds, it’s easy to be really, really sure. All you need to do is look at the price. That’s never failed yet in 140 years.

    With individual stocks, it’s harder. But it can pay off big if you are as good at finding the strong value propositions as someone like Warren Buffett.


  5. Bennett says an investor must not capitulate on the responsibility to monitor and decide on their own investments at a granular level of timing, by monitoring valuations. Bennett espouses everyone do this for themselves, claiming you MUST market time, apparently using his homegrown little java app.)

    But at the very same time, Bennett says it is perfectly okay to let the terrible, poorly run companies with no growth prospects and a poor track record get into your portfolio buy blindly indexing!

    It seems to me that if Bennett is to be true to his stated principles,then he must come down equally hard on indexers of all stripes, even if they are timers, because of their own lack of interest in making sure the get ONLY quality stocks into their portfolios. Surely the sin of just buying up everything on the shelf, instead of just the groceries you actually need, is at least as bad as not paying attention to the price tag of those goods.


  6. You are describing my position properly, HI. I advocate one form of passive investing and not the other. I don’t generally share your take that there is some sort of contradiction in supporting one form of “passivity” and not the other. But I think you are bringing up a good point that people should be thinking about.

    There are two ways to be “passive.” One is not to pick stocks, to just go with an index fund. The other is not to change your allocation in response to price changes, to stick with the same allocation at all times (Buy-and-Hold). I think indexing is wonderful. I think Buy-and-Hold is horrible. So it is certainly fair to say that I endorse one form of Passive Investing and am a harsh critic of the other form of Passive Investing. In that sense, yes, there is a small contradiction.

    The reason I support indexing is that it is so wonderful. It permits the investor to obtain very good returns without having to spend his nights and weekends doing research into stocks. What’s not to like? There is a downside to indexing. Indexers won’t get returns as high as those enjoyed by really smart stock pickers. But the 6.5 percent average real return obtained by indexers is plenty good enough to finance a middle-class retirement. I think indexing is a wonderful option for the typical middle-class investor. The creation of indexes (by our mutual friend John Bogle!) is one of the most important breakthroughs in the history of stock investing.

    How about Buy-and-Hold, the other form of passivity? Is there anything good to say about that? I am not able to think of anything. Buy-and-Hold (not paying attention to price when setting one’s stock allocation) has been tried four times in U.S. history. It has brought on a wipeout for all who followed it AND an economic crisis for the entire society that tolerated widespread promotion of it on each of those four occasions. Not good. I am not a fan. I have hopes of becoming known as the world’s most severe critic of Buy-and-Hold investing strategies.

    The connection between indexing and Buy-and-Hold is that they are both passive (non-active) strategies. That’s the similarity you are highlighting. There is at least a surface similarity. I give you that one, HI.

    But that’s all it is. To understand what is going on here, you need to look at the history by which indexing and Buy-and-Hold came to be packaged together. These two things were not combined because they were both non-active strategies. They were combined because they were both RESEARCH-BASED strategies. Bogle didn’t endorse Buy-and-Hold because it was passive. He did it because the academic research of the time supported the Efficient Market Theory, the idea that the market always prices stocks properly. Under the EMT, overvaluation is a logical impossibility. So investors do not need to worry about it. In a world of efficient markets, Buy-and-Hold is the ideal strategy.

    If the reason why many of us once followed Buy-and-Hold asset allocation strategies is that the research once supported them, the sensible thing to do when new research was published showing that Buy-and-Hold can never work was to abandon Buy-and-Hold and replace it with valuation-informed asset allocation strategies. That’s what we are seeing happen today. The popularity of Buy-and-Hold is in decline and the popularity of Valuation-Informed Indexing is in ascendance. Buy-and-Hold is in the investing strategy of the past and VII is the investing strategy of the future.

    The fact that Buy-and-Hold has failed is no reason to abandon indexing. Indexing is still supported by the research! Indexing works! Why would we want to give up what works just because some other thing we once believed in has been discredited? That would make no sense.

    Passive Investing is a very good idea when the thing you are being passive about is the stocks you own (because you have elected to invest in an index). Passive Investing is a very bad thing when the thing you are being passive about is your stock allocation (because you are still basing your investment choices on research that has been discredited for 30 years now). It might be better to use the term “Research-Based Investing” rather than “Passive Investing.” That term would permit changes in investing strategies as the research comes to teach us new things. Buy-and-Hold was research-based investing for the investors of the 1960s and 1970s. Valuation-Informed Indexing is research-based investing for investors living in the time-period from 1981 forward.

    I hope that helps to clear up the confusion a bit, HI.


  7. Rob, you’re so right. Buffet does several things most buy-and-holders don’t. Most important is that he waits for a good price to buy. Buffet’s teacher, Benjamin Graham, explained in “The Intelligent Investor” that anything can be a good investment – if the price is right. Pay too much for a great company, and you have a bad investment. Buy a weak company for a bargain price – significantly less than its net worth – and you may have a good investment. Buffet, I read, has sometimes waited years to get a good price for a great company. The market usually rewards such patience with temporary pullbacks. Since the market tends to move as a whole, even great companies can be pulled down in a market slump.

    Other characteristics of a good value buy are well known: plenty of cash, little or no debt, and plenty of free cash flow.

    One other anti-buy-and-hold point: when a stock ceases to be a good buy, when it’s selling for significantly more than it’s worth, it’s time to think of leaving. The conditions that led you to invest no longer apply, so it’s reasonable to go. In theory, this could lead to moving in and out of a stock over long periods as it’s price relative to value changes.

    Thanks, Rob, for a much-needed post.

  8. Bob – You’ve hit on a critical point with “when a stock ceases to be a good buy, when it?s selling for significantly more than it?s worth, it?s time to think of leaving. The conditions that led you to invest no longer apply, so it?s reasonable to go.”

    That’s really the key to investing in stocks, or investing in anything. We so want “forever investments”–that we don’t have to worry about–so badly that we wish them into existence inspite of reality. There’s a time for every investment, and a time to get out of every investment. A lot of people must have figured that out with the housing market in the past few years.

  9. But real estate “always” goes up! Or so we were told. I remember seeing a chart made by Shiller at Yale of real estate prices in constant dollars over the past century. There were three great surges: after the Second World War, the 1980s, and the recent bubble. Otherwise, prices didn’t really move. And real estate is highly illiquid, as so many have found.

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