For years, there have been two principle adjectives used to describe the buy-and-hold investment style: Dead or alive.
The buy-and-hold style was, of course, labeled as dead during and after the financial crisis of 2008, when anyone who stayed with their investments saw their portfolios get cut in half.
The same style is purportedly now alive and well, as anyone who stuck out their losses – or who jumped into the market after the turmoil – has seen a years-long rally that has recouped the losses and reached record highs.
The problem may be less with the style and more with the adjectives, because at least one leading money manager and behavioral finance expert now suggests that buy-and-hold is unrealistic and impossible.
Recently, Natixis Global Asset Management committed $1 million to a three-year research project by the Laboratory for Financial Engineering at the Massachusetts Institute of Technology to help figure out how investors can bridge the emotional gap between a desire to generate superior investment returns and an aversion to taking risk.
In discussing the project, Andrew W. Lo, director of the Laboratory for Financial Engineering – and manager of the ASG Diversifying Strategies fund (DSFAX), a Natixis issue – noted that the research is designed to tackle the really tough part of investing, the one where you put your hand back in the fire after you’ve been burned.
Standard advice typically amounts to “the market will be up in the long run,” encouraging buy-and-hold for decades.
“That might sound like good advice because on paper when you take a look at the S&P over the last 10, 20 or 30 years the performance looks pretty good the longer you go,” Lo said during an appearance on “MoneyLife with Chuck Jaffe.” “The problem is that advice is just not realistic. You can’t expect an investor to live through 2008-2009 and be perfectly happy to see their investments decline by 50 percent.
“You literally would have lost half … nobody is going to be rational to the point of not taking that information and reacting to it,” he added. “We are all emotional in that context.”
As a dedicated long-term investor, I can argue that point empirically by looking at my own portfolio, which went through the financial crisis virtually unchanged, with just a few small moves on the fringes but with the primary investments remaining the same.
I can also think back to those rough market times, however, and remember the nausea as the core of my portfolio was being gutted.
That emotion, in hindsight, is precisely why pure buy-and-hold can be, for most people, unrealistic.
Whether it is making moves on the edge of a portfolio or hiring a money manager who adapts and tries to guide the portfolio, it’s basic human nature to want to avoid pain.
Lo compared it to a different human imperative.
“It’s not credible to say to an investor, ‘Here’s a stock index fund, you ought to just keep your money in it and don’t worry about it and leave it there for 10 or 20 years,’” he said. “That’s like telling a teenager like he or she ought to abstain; it might be reasonable advice in the long run, but in the short run it’s very difficult to follow.”
No matter what strategy investors opt to follow – whether it is buy-and-hold or some rapid-trading, momentum-driven methodology – the necessary personal ingredient for success is emotional discipline, the ability to stick it out.
C. Thomas Howard, director of research at AthenaInvest and author of “Behavioral Portfolio Management” told me that the biggest problem investors face comes in accepting an investment strategy and following it as it is; they pick a strategy that they understand and like, follow it easily during good times, but then have a tough time the moment they question a trade, a stock pick or the results in the market.
“You can’t invest like a great investor if you’re not investing just like that investor,” Howard said. “You start to think you know better, or that there’s just this one thing they are doing that you don’t like, and suddenly you are changing. Now you are not following a successful system, you are modifying one; that may work out for you, or it may not.”
Howard noted that by cherry-picking the parts of a methodology they like – but ignoring or changing moves they’re less comfortable with – investors typically give themselves the wrong scapegoat for when something goes wrong. Invariably, they blame the adviser, newsletter editor, investment service or guru for failing when it was their own moves that altered the strategy.
“There’s lots of way to make money in the stock market, to be successful,” Howard said. “The key is that you have got to master your emotions, follow a narrowly defined strategy, and consistently take only high-conviction positions over time.”
Bring that back to the buy-and-hold strategy and recognize that the market is going to test your conviction. Ultimately, that’s what leads Lo to say that buy-and-hold forever can’t be done, even if most behavioral-finance guys say that it’s the strategy investors might benefit the most from.
That said, investors need to do some self-examination and perhaps give their portfolio several different approaches, one where the core of their holdings is something as simple as buy-and-hold, but where there is enough money being invested in other ways that it creates enough conviction to stay invested in good times and bad.
In the end, it may not be that buy-and-hold is dead, impossible or unrealistic so much as it’s that one piece of a puzzle for those investors who stomach it as one strategy in a multi-pronged attempt to come up with a portfolio they can live with in all market conditions; if you can’t live with buy-and-hold when it feels more like a fruitless duck-and-cover play – if you don’t think you can witness the carnage of 2008 all over again and remain invested – then you need to prepare for the days when the market again punishes buy-and-holders.
Knowing that now means you can protect against a downturn; finding out too late guarantees that your story will include the worst outcomes at the worst times.