Articles

What Does ‘Buy-And-Hold’ Really Mean?
By John Prestbo

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Friends, indexers, investors, lend me your tattered attention spans. I come to bury buy-and-hold, not to praise it.

The evil that buy-and-hold did from late 2007 through early 2009 lives on, and will live on for many years in the reduced retirements of millions. The Dow Jones Industrial Average fell 34 percent in 2008 alone, and if that was the year you planned to stop working, you probably were forced to rethink and retrench.

Authorities ranging from Jim Cramer to Bill Gross say the buy-and-hold investment strategy is dead, and they are honorable men. Of course, Jack Bogle, founder of the Vanguard Group, also is honorable. He doesn’t think buy-and-hold is dead, though he couches this position in terms such as, “We own the stock market, all of us together; we buy and hold it.”

The pundits eager to post death notices seem to portray buy-and-hold as a comprehensive investment philosophy that deserves to be discredited. After all, they point out, the Dow is at the same 10000 level it first attained in 1999. Grievously disheartened investors who bought then and held till now obviously were terribly abused by this ill-advised dictum.

But buy-and-hold is not a sacred creed that demands obedience. It is a three-word maxim, not nearly robust enough to be held accountable for the lost billions of retirement dollars. Like any rule of thumb, it needs to be applied with common sense. “A watched pot never boils” is a hoary bromide that is not literally true but conveys meaning nonetheless.

The subtextual meaning of buy-and-hold is: Don’t trade so much. This advice is anathema to ADHD investors and to pundits who dispense stock tips for prestige and profit. It chills the bones of the many on Wall Street whose sole purpose is to seduce you into chasing their latest investment ideas.

Buy-and-hold does not mean “buy indiscriminately and hold thoughtlessly.” If that were what it espoused, I would grab a shovel and help dig its grave. Properly executed, it means being selective about what you buy and holding it until it no longer serves your long-range purposes. At that point you would (gasp!) sell it and buy an equally well-selected something that does support your plan.

Notice that buy-and-hold says nothing about a plan, though I think there is consensus that a plan is the first thing anyone should have before becoming an investor. College tuition payments start in 10 years? Retirement might arrive in 2040? First, figure roughly how much money is needed for those life events, then how much should be (and can be) saved. Finally, allocate those savings among asset classes that in combination can be expected to supply a cushion of diversification while delivering adequate returns.

Only then, at about the fourth stage of this process, comes “buy”—which entails researching those vehicles in each asset class that seem likely to provide reasonable returns for that asset—“and hold.” Hold until when? Hold until the investment no longer represents the asset class. Or until market action has thrown the asset allocation out of whack against the original plan and rebalancing is needed. Or until the asset allocation itself must be modified to suit changed circumstances.

If those situations arise, some selling may be in order to get the portfolio back on track—or onto a whole new track, if that is warranted. Until then, though, if the asset vehicles are doing their job, hold on to them. Resist the urge to trade existing holdings for new ones in hopes of snagging a bit of “extra” return here or there. There is a bromide for that, too: Churn and burn. And pay commissions for the privilege.

It is possible to reduce the whole investment process to a series of three-word maxims: Make your plan. Keep on saving. Allocate your assets. Buy and hold. Review every year. Rebalance if needed. In this context, buy-and-hold does not stand out as egregious, does it?

Even so, the buy-and-hold obituaries are being published today for a reason. The bear market of 2007-09 devastated so many 401(k) and other portfolios partly because it was incredibly severe, surprising some “experts.” “Hang on,” they said, “it could be worse.” So, many people hung on and, sure enough, it got worse.