Insights & Advice

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Time-Tested Investment Theory Comes Under Attack

I am about to say something heretical, even life threatening to the investment community. As markets continue to decline and trillions of dollars of retirement money evaporates, an increasing number of investors, myself included, are taking issue with the argument that a Buy-and-Hold investment philosophy is the best approach for all individual investors over the long term.

My first beef with the theory comes down to this: what is long term for one investor may not be for another. If you are 75 years old, long term may mean a period of time far shorter than someone celebrating her twenty-first birthday. If you are saving for your four-year-old son’s college education your time horizon is far different than for a daughter who is fifteen.

Another issue is timing. Say you are 67 and retiring this year. You remained fully invested throughout this crisis and have now lost 50% of the savings you have been accumulating over the last 25 years. It would be a safe guess to say that for you a buy and hold strategy has been an unmitigated disaster!

Much of what we know about modern day investment theory stems from the findings of Harry Markowitz, an academician, who in 1952 developed the Efficient Market Hypothesis. He argued that a stock, bond or portfolio was considered efficient if no other asset or portfolio of assets offered a higher return for the same or lower level of risk. He believed that most markets were so efficient that the current market prices of securities reflected all information (public or private) available to investors. In its strongest form, this theory stated that it is pointless to try and achieve superior portfolio performance. The Buy and Hold strategy of investing is an off-shoot of this theory.

Let’s look at some historical results of a B&H strategy. If you had invested $1,000 in the S&P 500 index at the 840 level in 1997 you would have made nothing over the last 11 years following a B&H approach. Overseas it is even worse. Take Japan, for example, the Nikkei average is at the same level it was in 1981, the year I went to work on Wall Street. Honk Kong is where it was 14 years ago while France Germany and Italy are back to where they were over a decade ago.

The Buy and Hold crowd argues that based on your age and risk tolerance level a well diversified portfolio will do just fine over the next 25 years. They point to studies conducted in 1979 as proof. My problem is that the studies assume the next 25 years will be the same as the last 25. It won’t be. A huge number of baby boomers, for example, are retiring in the immediate future. Medicare and social security costs will be drastically higher. We are engaged in two wars. Who believes government spending will be the same as it was in prior years? I could go on but you get the point.

Besides, how has that well-diversified portfolio held up this year? It seems to me that with the exception of treasury bonds and cash everything has gone down the tubes in this sell-off. The theory’s defenders will argue that this market correction is an abnormality, something we will not see again in our lifetimes. That may be true but I think they said the same thing in 2002-2003 during the dot.com bust.

Regardless of who is right, I believe that by the end of this downturn there will be far fewer adherents to a philosophy that has produced little or no gains for most Americans over the last decade.

Posted in A Few Dollars More, Investment Styles