Why Buy & Hold Works

What I failed to mention in this tweet is that in order to earn that 93% gain, an investor would have had to first endure a 45% loss. There’s always a catch when looking back at historical market data.

One of the responses I received on this was that it’s impossible for an investor to ride it out in this type of scenario. I understand the sentiment here. It’s gut-wrenching to watch your stocks get cut in half. Most investors can’t handle those kinds of losses. Buy and hold is not for everyone, but for those who are able to extend their holding period, that’s a good thing. The fact that so many people feel that a strategy is impossible to pull off is the exact reason that it works over time. This is true of any successful, long-term approach.

Long-term is the key phrase here. Everyone wants to be a buy and hold investor during a bull market, but people change their tune when losses set in. For this strategy to work you actually need those weak hands. You need people to be non-believers. And there are always skeptics when it comes to buy and hold. When the market takes a beating, other investors are quick to point out the huge losses and when the market is soaring, other investors are quick to point out the fact that it won’t last forever.

In 2009, when no one, I repeat NO ONE, was predicting that stocks would end up at the levels they’re at today, Jason Zweig talked about the paradox of buy and hold at a time when many had completely given up on it:

But maybe it’s fine that buy-and-hold is out of fashion. To prevail as a successful long-term investing strategy, buy-and-hold has to go through a prolonged period when it no longer seems to work. As its weakest believers give up and fall away, buy-and-hold will ultimately emerge stronger. That may take a while; the rewards to patience are not always measured in years, but sometimes in decades or even generations.

I’m sure Zweig had no idea stocks would go on to more than double at the time time he wrote this. But that’s the nature of a long-term investment philosophy — sometimes you’re surprised on the downside and sometimes you’re surprised on the upside. You take the good with the bad.

Buy and hold feels easy right now. While some have failed to let go of their mindset from the financial crisis, others seem to have completely forgotten about how difficult it was to invest during that period. This is especially true if your plan called for you to continue to buy stocks as they did nothing but fall day after day. I covered the nature of a buy and hold investment strategy in my book with the following:

This isn’t to say that buy and hold is a perfect strategy by any means. It’s not. No strategy is perfect. Just because something is hard doesn’t mean you shouldn’t do it. The problem with a buy and hold strategy is that for it to work the way it’s supposed to, you have to do both the buying and the holding during a market crash. It’s much easier to both buy and hold when markets are rising. Get this right and you can be wrong in many other aspects of the investment process and still succeed.

Buy and hold isn’t for everyone. For those that choose to utilize this strategy, maybe that’s a good thing.

Source:
Buy and Hold is Dead. Long Live Buy and Hold (Jason Zweig)

Further Reading:
Why Does Buy & Hold Have to be Impossible?
The Psychology of Sitting in Cash

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  • If you are reinvesting all dividends, B&H is genius strategy for those with long-term timeframes. Watching your share count grow larger during periods of major “volatility” as divs buy more shares that are ‘on sale’ can be a comfort and/or help you leave well enough alone and stick to the plan w/o tinkering, trading, or (even worse) over-thinking.

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  • edinvestor1

    In order to be successful at “Buy and Hold”, you have to: 1. Have an endless firehose of new money spouting like Warren Buffett or, 2. Are wanting to pile it up for your heirs and never want to retire or, 3. You are a vampire and will almost live forever.

    • Steve

      If you are fully invested, you already did buy, so you simply have to hold, because the market has always gone up again. Getting out is what causes the failures, locking in your losses and missing the gains.

      • edinvestor1

        My point is we all die in the long run and there have been periods where it took a decade for the averages to come back and longer with inflation accounted for. Also,a little known fact is that the averages cull out stocks of companies that are failing so their effects disappear without causing a ripple to the averages and causes them to show better then true results. Those companies affect those that held their stock. Because of limited lifespans and uncertain outcomes, it is difficult for the average person to hold on psychologically.

        • Ben

          You also have to define what buy & hold really means. For most it’s not just buy and hold forever — it’s buy, hold, diversify, rebalance and change your asset allocation as your risk profile changes.

    • Ben

      You win so far for comment of the year on the vampire angle. Well done

  • Steve

    I’m not sure I agree that for buy and hold to prevail, it has to go through a period when it no longer seems to work. Why is that? Is he saying if most investors did just buy and hold, or at least held, then it would fail somehow? I’m also surprised you say Zwieg had no idea stocks would go on to double when he wrote that. Or did you mean he didn’t know the market comeback was about to begin when he wrote that? Eventually, after all big bear markets the market doubles or even triples as it moves to all time highs. Without all time highs the market would go nowhere. It has always come back, in spite of so called “experts” incorrectly stating “it’s different this time” after each bear market.

    • Ben

      What I’m trying to say is that if everyone was a buy and hold investor it wouldn’t work as well. The fact that some investors bail out during a market crash and give up on long-term investing often amplifies the downturns. Lower stock prices and higher dividend yields help those who are willing and able to continue buying or rebalance into lower prices.

      In 2009 I don’t think anyone was predicting this type of rally to go so far so fast.

    • slotowner

      One of the reason why buy & hold works is because not every can take advantage of it so those who can get a benefit.
      If your 20 years old & you get to put money in a magic box that will grow some amount but you can’t open it until you 59 ½, would you really care if in 10 years it drops & then grows fast & it does the same thing ever for ever 5 years after?
      Over decades the growth of the stock market is the growth of the economy and it is rare for the US or world economy not to grow over a decade & really low that it won’t grow over several decades. There is one main reason why the US is projected to grow over time & that’s because the US is expected to have a positive population growth & more people grows the economy. If the economy keeps on making new highs, then the market will follow the same pattern.
      If you have time & you really can’t access your money or if you have the will to let it ride then even yearly fluctuations don’t matter much & that allows you the ability to take a strategy that others can’t.

  • Jim Haygood

    Buy and hold is best pursued with a dollar cost averaging approach. High prices and low prices will average out over time. But for a person who receives an inheritance, or an organization that receives a large bequest, the price paid for stocks matters a lot.

    Like real estate brokers, sell-side stock brokers will always claim that NOW is a great time to buy. But it isn’t. Anyone who piles in with a lump sum in the 7th year of a bull market is going to learn that they could have waited and bought at a better price.

    • Ben

      This is true. The majority of people are investing in bits and pieces over time and a simple DCA is the best way to invest. When you’re dealing with a lump sum you have to account for not only the market environment, but also the psychological issues that can come from going all-in all at once. In this case a modified DCA with a flexible plan if markets crash is probably not a bad idea either.

    • MG

      This is simply incorrect. Numerous studies have shown that when you compare the historical performance of dollar-cost averaging
      (DCA) with lump-sum investing (LSI), markets in the United States (as
      well as the United Kingdom and Australia) on average,an LSI approach has outperformed a DCA approach approximately two-thirds of the time, even when results are adjusted for the higher volatility of a stock/bond portfolio versus cash investments. This is over only 10 year rolling periods, so it does not take that long to come out ahead with lump sum investing. This finding is consistent with the fact that the returns of stocks and bonds exceeds that of cash over most 10 year periods from 1926 through 2011 in each of these markets.

      Of course this assumes that you can NOT PANICK (or worry yourself to ill health) if a scenario of a large drop shortly after LSI plays out. DCA is usually less rewarding financially than LSI, but for many DCA is much easier emotionally, which counts for a lot too. After all, the best approach only works if you can actually follow through with it during the tough times.

      • Ben

        Life doesn’t play out like a spreadsheet so it makes sense to take into account the individual you’re dealing with. Those studies are helpful only up to the point that a person understands them and knows both sides. Here’s an older post I did on this:

        http://awealthofcommonsense.com/diversifying-across-time/

      • Jim Haygood

        Since markets offer a long-term positive return, an LSI approach may well beat a DCA approach if every year is tested.

        My claim is that LSI does not win if a valuation indicator such as Shiller’s CAPE (currently at 93rd percentile) is at a high level, which means weak prospective returns.

        And even more specifically, that a patient lump sum investor will be able to buy at a lower level than today’s S&P close of 2107. Valuation matters, just as it did for real estate investors who piled into Las Vegas houses in Jan. 2006.

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  • annelykke

    No, faulty premise. Lots of places to get back in.

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  • tedfeely

    Buy & Hold Works until it doesn’t. If you can afford to lose a chunk of money, then it seems to me Buy and Hold is worth including as a strategy for a portion of your funds. But, if you are investing money that you can’t afford to lose (or tie up for long periods of time hoping it will recoup losses) I would not and do not trust the strategy. What if you had been a Russian with all your assets in the market of 1918, where were those funds in 1923, 1933, 1943, 1953, etc?How about the German market prior to the huge inflation of the 1920’s?

    Caution, it seems to me, is on the side of diversifying your strategies as well as your investments.

  • ciwood

    I have learned that buy and hold can work if you have allocated for your experiential risk level. After much anguish, I had settled on a 50-50 stock and bond allocation before the 2008 debacle and was able to hold without selling. I just kept telling myself that my neighbor was was losing his house and I was just losing my shirt!

    • Ben

      Totally agree. Risk tolerance and asset allocation are the keys. As long as you’re able to force yourself to occasionally rebalance and you’re comfortable with the mix.

  • tedfeely

    I was a Buy & Hold investor in 2008.

    At that time it looked like our whole financial system was threatened and it was completely unclear how the market would come out of it and I was looking at my nest egg disappearing, I lost my nerve and sold about everything I was invested in.

    That was one of the best things I ever did. It freed me from constant worry. It put me into cash so I could think about what I might want to invest in later. etc. I lost nerve early — I’m a skittish investor — sometimes derisively spoken of as “weak hands” investor — which was luck for me since I got out well before the bottom.

    I’d like to say that I invested all that cash at the market bottom, but I didn’t know the market bottom until after it had happened. (It’s a funny thing — living life in forward motion is a lot more challenging than living it in retrospect which brings me to a pet peeve.) Namely, how many times have you read about the virtues of Buy and Hold when things are at the bottom? In February 2009 when stocks where near the bottom, how many buy and hold investors wrote about how wonderful it was to be fully invested? (OK. Maybe Jason Zweig.) But, when stocks are near or at all time highs, the virtues of Buy and Hold look so good. (I’m not criticizing Ben’s argument, but simply trying to put things in some perspective.)

    So, here’s my suggestion (and I’d like to hear comments): take a portion of your funds, a portion that you can truly live without, and, now that the market is at all time highs (or nearly so) invest it long-term, but not all of it at one time.

    Plan for market corrections and build that into your strategy. For example, leave sufficient cash to double your investment in any given position after a 20% “correction.” So, let’s say you put $10K into a position. It retraces down to 80% of the original position ($8K), Leave sufficient funds in cash or something safe and liquid to double the $8K position bringing your investment up to $16K. (This means that you would originally allocate $18K to eventually fund this position.) ($10K – $2K = $8K + additional $8K = $16K; funds needed $10K + $8K)

    I’m actually planning on 2 retracements so, using the above guidelines, that leads to starting with $30.8K to end up with something like a $25.6K position, but at a substantially lower price than today’s market.

    BTW: I plan to use the unused cash portion of this strategy for intermediate term trading.

    Thank you (I think) for any comments.

    • Ben

      Whatever works for you is my motto. I definitely agree you only want to have enough allocated to a B&H portfolio that you’re willing and able to sit through a crash or bear market. It doesn’t matter how much you have in stocks if you can’t take the pain.

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  • J.C. Webber III

    Is ‘buy and hold’ still a viable strategy once you are no longer in the accumulative phase of your investment life, but are now in the spending (retired) phase of your investment life?

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