History Says Implementation Not Easy
There are many different ways to invest, including using a diversified portfolio
of ETFs and/or mutual funds. For example, we recently saw the allocation below
described as the best way to invest for long-term growth based on the best
research and over 45 years of investment experience.
Intelligent Robots Build Pie Charts
Our purpose here is not to question the long-term performance of the allocation
above, but rather to demonstrate the difficulty of staying invested during
good times and bad times, a requirement to successfully capture the benefits
of any buy-and-hold portfolio. This topic is very timely with the recent rise
of the "intelligent robot built portfolio", which typically involves building
a pie chart based on history, investing in the pie chart, holding the pie,
and rebalancing the pie from time to time.
Key To Success Is Proper Implementation
History says buy-and-hold is a legitimate strategy. Our concern lies with
investor knowledge relative to proper implementation of buy-and-hold from three
perspectives:
- Stocks can literally go decades without making any progress.
- Successful buy-and-hold and rebalance requires that investors hold through
a full market cycle (good and bad times).
- Buy-and-hold and rebalance allocations can get hammered in a bear market,
making it very difficult to successfully implement the "hold" portion
of the strategy.
Stocks Typically Zig And Zag In Unison
Assume we decide to use "the best way to invest for long-term growth" allocation
above. The chart below demonstrates the "best way to invest" allocation for
the most part goes up when the market goes up and goes down when the market
goes down (it has a high correlation to the S&P 500). Therefore, the performance
of the "best way to invest for long-term growth" portfolio will be heavily
influenced by the performance of the major indexes (S&P 500, Dow, NASDAQ,
etc). The same argument applies to the equity portion of any allocation, even
one that includes bonds.
If Your Plan Requires Growth...
If my retirement game plan requires that I grow my capital, what does history
tell us about dead periods for stocks. Assume we were 50 years old in 1929
and five to ten years away from retirement. If we invested in the stock market
at age 50, we would have waited until we were 76 years old just to get back
to break even. As shown in the chart below, it took 26 years for the market
to get back to the same level it was in 1929.
The text below comes from a Forbes article
written by Sy Harding:
"In the 1929 crash and its aftermath the market lost 86% of its value
and did not get back to its 1929 level until 1955, twenty-six years later.
That was 26 years of waiting for buy and hold investors (if there still
were any) for the market to 'come back'.
Well, That Was A Unique Period, Right?
It is fair to say 1929 to 1955 was a unique period. Assume we were 55 years
old in 1965 and five to ten years from retirement. If we invested in dividend-paying
blue chips to grow our capital, we would have been very disappointed. As shown
in the chart below, the Dow Jones Industrial Average hit 1000 in 1965 and did
not exceed that level for any significant period of time until 17 years later
in 1982. Therefore, the Dow made no progress between age 55 and age 72 for
our hypothetical investor. The S&P 500 followed a similar path over the
same period.
Sy Harding described the period this way - from Forbes:
"In 1965, just 11 years later, when the Dow reached 1,000 for the first
time, the long 1965-1982 secular bear market began. For the next 17 years
the Dow cycled between cyclical bull markets and cyclical bear markets,
but did not manage to rise above its level of 1965 until late in 1982.
It was another 17 years in which buy and hold investors (again if there
were any left) waited for the market to come back. Seventeen years of whipsawing
heartbreak for buy and hold investors, but wonderful opportunities for
market-timing. That made a total of 41 of the 53 years between 1929 and
1982 that buy and hold investors were waiting and hoping for the market
to get back to previous levels."
The Modern Markets Are Different, Right?
Since the whole premise of buy-and-hold and rebalance is based on historical
returns and stock market history, it makes sense for a buy-and-hold investor
to understand the more difficult periods in history. You might say: the market
and economy are much different than they were in 1929 or 1956. Assume we were
58 years old in 2000 and five to seven years from retirement. Any investment
related to stocks in our portfolio most likely made very little progress between
age 58 and age 70, given the S&P 500 made no progress between 2000 and
2013.
If We Have To Hold, How Bad Can It Get?
Remember successful implementation of buy-and-hold and rebalance requires
that we hold the mix of ETFs/mutual funds through the good times (bull market)
and bad times (bear market). Therefore, to increase the odds of holding during
the bad times a fair question is how bad can it get? This week's stock market
video examines the performance of the allocation below day-by-day during the
financial crisis bear market (2007-2009), allowing an investor to understand
what they might have to endure to capture the full cycle benefits of buy-and-hold
and rebalance.
The video also shows the performance of a diversified portfolio of mutual
funds during the dot-com bear market.
Video: Are You Really Diversified With ETFs And Funds?
History Says Buy-And-Hold Works
We want to emphasize we are not questioning what history says about the returns
related to buy-and-hold and rebalance. Our concern is one of implementation.
How many people that were sold on the benefits of the "best way to invest for
long-term growth" portfolio over the past few years were also told the allocation
lost almost 60% in the last bear market? If you do not understand how ugly
it can get, then the odds of holding through a full market cycle are lower.
If you do not hold through the good and bad times, buy-and-hold will not work
as advertised.
Finding A "That Makes Sense To Me" Approach
Buy-and-hold is not the only strategy that requires discipline to implement
properly. For any strategy to be successful, it must be properly implemented
in good times and bad times. Our job as investors is to find a "that makes
sense to me" approach, allowing us to stick with it over a full market cycle.
Buy-and-hold is a proven commodity, but it is not the right approach for everyone.
There are many ways to skin the risk management cat.
