Why buy-and-hold-forever doesn’t work

Anyone can see that the market has been on somewhat of a rollercoaster lately. Normally, investors think of markets in binary terms. They’re either a “bull” or a “bear” with consistent increases in value or drops. Vitaliy Katsenelson, an investment manager and adjunct faculty member at the University of Colorado-Denver, argues that we’re actually in a “range-bound market”. Range-bound markets are basically long periods where the market goes up and down in the shortterm, but over a longer period goes nowhere.

Take the period between 1966 and 1982.

For about 15 years, the S&P 500 didn’t really move up or down. That means buy-and-hold investors’ portfolios pretty much stood still. For anyone relying on those historical 10% average annual returns that personal finance magazines always brag about, that kind of dry run can be as scary as a bear market.

Of course, in reality, investors who bought and held didn’t have it all that bad. Dividends probably made their real portfolio returns in the 3% to 5% range. That’s still not anywhere close to the market’s historical average.

So what do you do? In “Active Value Investing: Making Money in Range-Bound Markets”, Katsenelson argues that investors must take an active role in their portfolios if they want to get more than those dividends. Instead of buying an index fund, investors need to focus on stocks with low P/E ratios (and other value metrics) and strong brands if they want to get share appreciation in addition to those dividend payments.

In my opinion, buying an index fund and holding is still probably the best method of increasing wealth for the average investor. If you have no time to analyze stocks or are dollar-cost averaging (pretty much every 401k investor out there), you’d be better served to buy a fund and be done with it rather than take your chances and possibly lose a lot of money in a value trap.

But we also shouldn’t assume that we’re going to get a 10% return just because that’s what investors got over the last 80 years. Buy-and-hold forever isn’t an investing “strategy” per se, but a prayer that the U.S. economy continues to grow at a pace that will give us enough to retire on when the time comes. Not a bad bet, but a prayer nonetheless.

– Joe Light


1 comment so far

  1. freemarketswork on

    The problem with “buy and hold” is what you buy. I partially agree with you on “buying and holding an index fund….” and I said partially because holding just one index fund is good, but not great. What investors should do is own the market as a whole (and that means buy index funds in different asset categories) and not only hold them forever, but rebalance their portfolios frequently.
    As a Financial Advisor, I’m moving my practice from recommending “actively managed” funds to 100% index funds. Why? Because I believe that actively managed funds are a disservice to investors and the only ones that make money are the fund managers and the brokers, leaving investors just the crumbs of what they’ve taken.
    Are there outperforming funds? Of course there are, the problem is identifying them in advance consistently and predictably.
    I started freemarketswork.net to share investors with this view on money management, obviously your comments, if any, would be more than welcome specially considering your background (btw, loved the “new ride” part on “the future of your money” story, I actually used some of the tools you put there and saved over $1,500 off the MSRP of my new car when I bought it last september)

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