An Alternative to Buy-And-Hold

Posted on December 20, 2016

"If you want to make money, really big money, do what nobody else is doing. Buy when everyone else is selling and hold until everyone else is buying. This is not merely a catchy slogan. It is the very essence of successful investment." - J. Paul Getty

The topic of trend following, and our MarketVANE strategies in particular, are obviously central to many of our conversations with clients. We field many questions about the potential value-add of a tactical allocation strategy over a more static buy-and-hold approach, and our process can even be confused with what is traditionally referred to as “market timing.” Common objections point to the fact that the US stock market has never had a negative return over a rolling 20 year period and that the US stock market has outperformed all major asset classes such as real estate, bonds, and cash over the long-term. While both of these statements are indeed true, we disagree with the conclusion that the best investment for the long-term should therefore be a buy-and-hold portfolio of just US stocks.

There are several reasons why the buy-and-hold gospel has gained so much popularity over the past several decades. For starters, this period of time has been one of incredible success and prosperity for our country. Over the past century and a half, the United States has grown from an emerging economy to the wealthiest and most powerful country on earth, which has equated to tremendous performance for the US stock market. We readily admit that most investors over this time period would almost certainly have been better served putting their money into the market and leaving it there versus trying to time the market by predicting tops and bottoms based on their conviction or gut level intuition.

To solidify this point, the most recent publication of DALBAR’s annual Quantitative Analysis of Investor Behavior found that over the past 30 years average investor returns in US equity mutual funds have lagged the S&P 500 by more than 6.5% a year (3.66% vs. 10.35%). The study stated that “investor behavior is the number one cause” of the underperformance. The conclusion many drawn from this type of analysis is that one should never try to time the market. But going one layer deeper, the real conclusion from this study is that following one’s gut conviction based on changing sentiment/emotions is detrimental to long-term investment returns. That conclusion still leaves room for investment strategies which systematically manage risk by being in and out of the market based on mathematical approaches that are disciplined and reactionary rather than being predictive in nature.

The surface layer conclusion (e.g. all market timing is bad, therefore buy-and-hold is the only answer) is the one many academics and financial professionals have adopted, but there are several problems with this conclusion.

1. There is no guarantee that the future will look like the past. As previously mentioned, the US has been an incredible success story, but what if the next 30 years look more like the last 30 years of Japan’s stock market rather than our own? Japan also was an incredible success story until it wasn’t. The Japanese stock market peaked 27 years ago this month and is still underwater from its peak even after factoring in the reinvestment of dividends.
2. Investors have different investment time horizons. Even if the US stock market was guaranteed to make a positive return over the next 20 years, it still doesn’t mean that a buy-and-hold allocation to US stocks is the right portfolio mix for someone living off their portfolio. In the same way that dollar-cost-averaging works in one’s favor during the accumulation phase, it works against you in the distribution phase. Path dependency matters!
3. Not every investor is wired the same way. For some individuals, buy-and-hold is a terrible idea because someone without the fortitude to hold investments during a major sell-off will most likely betray their buy-and-hold conviction at the most inopportune time. We have spoken to many folks who sold at the bottom of the last collapse only to watch the market recover, leaving them paralyzed as to when to buy back in.
4. The risk of holding stocks is not always justified by the reward. The idea that it is always a good time to own stocks is simply wrong. There is plenty of research that shows how valuation (a known metric without the benefit of hindsight) is a significant driver of future performance. Simply put, you are much better off putting money to work when stocks are cheap rather than expensive by historical standards.

Ultimately, there are a number of different ways to solve the retirement puzzle. Buy-and-hold investing is one perfectly legitimate strategy, but it is not a one-size-fits-all solution that every investor should follow. The proliferation of this investment philosophy, which has become borderline gospel in some circles, stems from the fact that it is easy to implement and manage, which consequently is something that comes in handy for a financial professional trying to manage hundreds if not thousands of client accounts.

At Season Investments we have chosen to borrow a page from the investment playbook of the ultra-wealthy and institutional investment community who spread their investments across multiple asset classes in addition to the stock market and actively manage risk. This style of investing can take on many shapes and forms, but for us it is informed by the humility of admitting that we can’t predict the future returns of any asset class. This is why we invest in more than just stocks and bonds (Diversification 2.0) and rely heavily on quantitative techniques (MarketVANE) which reduce the Cost of Being Human, thereby reducing the impact emotions can have on our investment performance.

J. Paul Getty’s opening quote is a perfect example of how the ultra-wealthy think in terms of investing, stating that there are both times to buy and times to sell financial assets. This, by the strictest definition of the phrase, might be considered market timing. By the same token, trend following techniques such as MarketVANE may also be considered a form of market timing. But unlike many investors who are trying to time the market by predicting the future based on gut level convictions, trend following simply reacts to changes in price to get in-line with the prevailing trend. Another word for trend following is momentum investing, which various academic studies have shown is able to add excess returns to a passive investment strategy similar to value or small-cap investing. In conclusion, the phrase market timing has become a dirty word in investing, but be careful not to throw the baby out with the bathwater. As the saying goes, the devil is in the details.

Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

Subscribe to our Weekly Insight via email!