Buy and Hold is not Dead – It was NEVER Alive

After the crash of 2008, many peoples faith in the Buy and Hold approach to financial freedom is on shaky ground.  For a long time the Buy and Hold strategy has been pushed strongly by financial planners and the mutual fund industry.

To sell ‘Buy and Hold’ as the way to go, compelling statistics are produced about how historically stocks have outperformed other asset classes.  How despite a few ‘bumps’ along the way “over the long term you can’t lose”.
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Buy and Hold

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But never take anything that you have been told as fact until you have done your own research (especially when it involves your finances).  As you are about to see, the reality is that Buy and Hold is not dead, it was never even alive and was simply dreamed up as a marketing ploy by those who would stand to profit from your believing in it.  Perhaps a better description would be Buy and Pray.
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What is the Average Stock Market Return?

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When people talk about returns available for the Buy and Hold investor they generally quote the historical performance of the US market, specifically the Dow Jones Industrial Average.  Several ‘Experts’ have told me that the average stock market return you can expect is 8 – 15% per year.  To quote from ‘Money Secrets of the Rich’ by John Burley printed 1999:
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…compounded returns averaging more than 14%+ over the last 45 years…[1]

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This is such a half truth it is a lie!  To mislead people into believing that by simply using a Buy and Hold strategy they will achieve returns of this nature is irresponsible!

Over time Buy and Hold returns on a broad index like the S&P 500 will match the average earnings yield and GDP growth.  Robert D. Arnott and Peter L. Bernstein found that the real stock returns over the past 192 years averaged 6.1% derived from three components; an earnings yield of 5%, per capita GDP growth of 1.7%, less 0.6% shrinkage of dividends relative to real per capital GDP growth.[2]

From 1929 to 2008 I calculate the average stock market return on the Dow Jones Industrial Average at just 4.28% without allowing for inflation.  That is far short of the 8-15% that most Buy and Hold investors promote as the investment returns that can be expected.  The scary thing is that people are basing retirement projections on such forecasts; for the 380 companies in the S&P 500 with defined-benefit plans, projected returns average 9%.[3]
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The U.S Was a Top Performer

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Another misleading factor is that during the 20th century the US had the worlds 4th best performing stock market after inflation.[4] This history of stellar growth in the US is something that we take for granted but it is unlikely to continue.  With no intention of being anti American I am simply stating a fact based on historical trends that it will be very difficult for the US market to be one of the top global performers during the 21st century.

Time brings many changes, 2000 years ago China and India combined accounted for 59% of the worlds GDP.  By 1950 Western Europe and the US had taken command with 53.5%.[5] That hold has since slipped and over the last 55 years China and India have grown their share of the words GDP from 8.75% to 22.07% (1950-2005), while the US and Western Europe now account for 38.24%.[6]

The next 50 years are likely to bring change at a faster pace than at any other time in history and it will put to test the US’s commitment to the global trade system.  The rising forces of China and India will cause disruptions to workforces, industries, companies, and markets in ways that we can only begin to imagine.  In the 19th century, Europe had to go through a similar test when it realized that a new giant was emerging; the US.  World leading corporate strategist Kenichi Ohmae said:
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It is up to America to manage its own expectation of China and India as either a threat or opportunity.

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As long as calamity doesn’t strike, most economists predict that China and India have the ability to keep growing at an annual rate of 7-8% for decades because they have younger populations, higher savings rates, and so much catching up to do.[7] At current projections China is likely to take the No. 1 position from the US and become the world’s largest economy before 2020.[8] By then, China and India could account for half of global GDP.  If this takeover does occur then a Buy and Hold strategy on the US market is going to produce disappointing results.

Warren Buffett put the reality of the situation brilliantly in his 2007 letter to Berkshire Hathaway Inc. shareholders:
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During the 20th Century, the Dow advanced … 5.3% when compounded annually … Think now about this century.  For investors to merely match that 5.3% market-value gain, the Dow … would need to close at about 2,000,000 on December 31, 2099 … While anything is possible, does anyone really believe this is the most likely outcome? … People who expect to earn 10% annually from equities during this century … are implicitly forecasting a level of about 24,000,000 on the Dow by 2100.  If your adviser talks to you about double digit returns from equities, explain this math to him … Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.”[9]

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“Buy and Hold and you can’t lose long term” …But how long is long term?

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Buy and hold advocates constantly remind us that if we hold a diversified portfolio for the long term then we can’t lose.  Well, just how long is the long term?

One investment advisor told me that if you Buy and Hold for 20 years or more then your risk in the stock market is reduced to zero.  Some say less… This from Mutual of America’s website:
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There has been no 10-year period in the previous 50 years that has resulted in a downtick in the S&P 500.[10]

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As Benjamin Disraeli said “There are three kinds of lies: lies, damned lies, and statistics.”  Mutual of America had revenue of 1.77 billion[11] in 2008 and they boast of “strong portfolio management teams and significant research capabilities”.[12] Yet despite their well funded research they can’t do simple maths.  Before allowing for inflation there has actually been 6 (and counting) ten year periods over the last 50 years that have resulted in a downtick for the S&P 500 and the Buy and Hold investor:

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Buy and Hold Lie
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So what is the longest period with no growth for the Buy and Hold investor?

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Would you be shocked to hear that the US has had three periods longer than 57 years where the stock market has experienced no real growth including one period of 130 years?  Robert Arnott in a stunning article called ‘Bonds: Why Bother?‘, revealed that the market drop from 1929-1932 was so severe that in real terms stocks fell below 1802 levels.  This erased 130 years of market gains:[13]
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Buy and Hold After Inflation

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Why do mutual fund promoters overlook this kind of research and mislead people into thinking that a Buy and Hold strategy is the best way to go?  Because they make huge fees out of managing your money and the last thing they want is for you to withdraw your funds in a bear market.  At the end of the third quarter 2009, equity mutual funds held $8.53 trillion dollars under management.[14] That makes promoting the Buy and Hold myth worth HUGE dollars.
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Summary

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Here is a prime example of how in the financial markets more than any other industry, one must be very aware of who is producing the statistics that are being used to influence your thinking.  (I am a trader so remember, I have a bias in the way that I present this information as well.)

Unfortunately the fact is that Buy and Hold as a strategy just does not stand up to scrutiny.  Having said that, Buy and Hold as a strategy is certainly better than not investing at all.  We may even get lucky and see the market embark on another 20 year period of above average growth like we saw from 1980 to 2000 when the S&P 500 advanced over 1200%.

But… you should never rely on luck when it comes to your financial future.  The reality is that over the long term the return from the stock market must match the growth of the economy, whatever that ends up being.  In the interim stocks undergo a constant battle between what they are truly worth based on the fundamentals and what the irrational, emotional, ‘Greater Fool’ is willing to pay.

If you are to ensure long term success with your finances regardless of what happens in the economy you must have an edge over the market.

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Incidentally, if you don’t know what your edge is, you don’t have one. – Jack Schwager

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So you have seen my research… Do you still believe in Buy and Hold? Share your thoughts in the comments section below.
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  1. ^ Money Secrets of the Rich by John Burley, 1999
  2. ^ What Risk Premium is Normal? by Robert D. Arnott and Peter L. Bernstein. Financial Analysts Journal, March/April 2002, Vol. 58, No. 2, Page 74, Paragraph 3
  3. ^ The Pension Crisis Revealed, 2003 by Frank Fabozzi and Ryan Ronald. Journal of Investing Volume 12, No. 3
  4. ^ Triumph of the Optimists: 101 Years of Global Investment Returns, 2002 by Elroy Dimson, Paul Marsh, Mike Staunton. Page 52, Table 4-1
  5. ^ Contours of the World Economy 1-2030 AD Essays in Macro-Economic History, 2007 by Angus Maddison. Page 261, Table 8b
  6. ^ Statistics on World Population, GDP and Per Capita GDP, 1-2006 AD, March 2009, Horizontal File
  7. ^ Why the world must watch out for India, China by Pete Engardio. Businessweek September 12, 2005
  8. ^ China’s Economic Performance: How Fast Has GDP Grown; How Big is it Compared With The USA? February 22, 2007 by Angus Maddison and Harry X. Wu. Page 1, Paragraph 1
  9. ^ To the Shareholders of Berkshire Hathaway Inc. February 2008 by Warren E. Buffett. Fanciful Figures – How Public Companies Juice Earnings, Page 19, Paragraphs 3-8
  10. ^ Mutual of America, Capital Management Report, Stocks, S&P 500, Paragraph 3 (Screen Shot)
  11. ^ Mutual of America 2008 Annual Report, Financial and Corporate Information, Consolidated Statutory Statements of Operation and Surplus, Page 51
  12. ^ Mutual of America 2008 Annual Report, Discipline, Page 19
  13. ^ Bonds: Why Bother? May / June 2009 by Robert Arnott, Rethinking Fixed Income. Page 2 Paragraph 7
  14. ^ Worldwide Mutual Fund Assets and Flows, Third Quarter 2009, Worldwide Assets of Equity, Bond, Money Market, and Balanced/Mixed Funds.  Billions of U.S. dollars, end of quarter.

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Leave A Reply (10 comments so far)


  1. Rhys Coffin
    7 years ago

    Brilliant insight Derry. As someone looking for better investment strategies, I would be interested in your opinion on other alyernative strategies especially for investors new to the market.


  2. Derry
    7 years ago

    That is a big question Rhys because there are so many possible answers. Unfortunately it is not a matter of one size fits all.

    Any strategy that you use must take into account for your personality, risk profile, knowledge, desire to learn and time available.

    Allover the net one will find gurus promoting seminars and courses that promise to teach people how to make a fortune in the market by the end of the week. But I only know of one well paid profession that can be learnt in such a short amount of time… (its the oldest profession in the world)

    I share my trading strategies, the tools that I use and the signals from several of my trading models in the weekly ETF HQ report. You can subscribe to it for free using the form at the top right of this page if you haven't already.

    Our newsletter readers are welcome to emulate my strategies IF they suit their personality. However the content of the emails is intended to complement our readers many different trading styles and approaches.

    In the future we may provide more involved services to a limited number of paid clients.

    Thanks for your question and please let me know if you have any others.

    Cheers
    Derry


  3. Youngandthrifty
    7 years ago

    excellent excellent research Derry! You could write a book about this, seriously! You have good insight and your argument definitely is backed up.

    Perhaps buy and hold isn't a bad idea for dividend investors, but yeah, I agree- nothing's really fairing very well right now if I had bought and held 5 years ago, when I started investing. Makes sense to take an active approach.


  4. Derry Brown
    7 years ago

    Thanks for your kind words Young and Thrifty. I also enjoy your blog.


  5. Bruce Bryce
    6 years ago

    Your chart says it goes to 2009 on the title but it only goes to 2001. I would love to see an updated chart. Very interesting points!


    • Derry Brown
      6 years ago

      Hi Bruce,

      I am glad that you enjoyed it. The chart does go up to Feb 2009 it is just that the years are marked every 20 years starting in 1801.

      Cheers
      Derry


  6. james moylan
    6 years ago

    I have aweb site where I research stocks under 5 dollars I have many years of experience with this sort of stocks. I would like to comment about buy and hold I am a buy and hold investor to a point. not buy and hold forever their many stocks trading today that if you would have just bought and held you would have been hansomly rewarded a few examples apple computers shares traded at just 5 dollars a share in 1998 today they traded at 360 dollars petsmarts shares traded at 2 dollars ten years today they they trade at 39 dollars. and ford motors shares traded at 2 dollars just two years ago today they trade at 19 dollars.


    • Derry Brown
      6 years ago

      Hi James,

      What you say is very true, buying and holding the right stocks is a fantastic way to get big returns… if you pick the right stocks. But there is the problem, you have to stock pick. Buy and hold as I am referring to it in this article is about buying and holding a diversified basket of stocks or an index fund.

      Thanks for your comment
      Derry


  7. Bill
    6 years ago

    PLUS, the indexes are constantly changing; the DOW of 1950 or even 1990 is completely different from that of today – under-performing stocks are delisted and the next big thing is added to the mix.  I would be very curious to see what your return would be buying and holding the dow from ANY given year in the past.  For example, if you bought the DOW from 1950, how many stocks would still be in existence today?  What would your investment be worth??


    • Derry Brown
      6 years ago

      Interesting question Bill.  With the advent of DIA and other ETFs is is very easy for the retail investor to track indices like the Dow without having to worry about managing a portfolio.  Only 5 of the current 30 companies in the Dow were part of the index in 1950: NTX, PG, GE, XOM and DD.  Of the original 12 stocks from 1896 only GE remains, 10 out of the other 11 still exist in some form but most have changed their names, been broken up or merged with other companies.

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