Buying And Holding On… For Dear Life?

23849762_sThere are a few dates in history that everyone in the financial industry remembers. Many people don’t realize how recently one of those memorable days came to pass—August 24, 2015, is not too far behind us. It claims the title as the day with the largest one-day point drop in the history of the markets. Actually, since July the markets have had a rough time, down over 11 percent at times.
Heck, I realize that investing in the stock market can feel like the cruelest of games. But with interest rates so low, investing in the stock market, particularly through mutual funds, tends to be one of the only wealth-building solutions that have been offered to the average American. You know, the one who works hard, raises kids, pays for college, and saves money in the hopes that one day, he or she can retire. It’s your neighbor across the street, your kid’s teacher, the policeman, it’s you, and it’s me.
What makes this game not only cruel, but dangerous, is the concept accepted by so many, and often referred to as the “buy and hold” philosophy. The market goes up, the market goes down. That’s just the game we play with investments. We have no choice but to hang on tight for the ride. Right?
Look folks, since 1900, markets have gone through a major correction every five to six years, with 2008 being the last. So was the largest one-day drop in August a path for what is to come, or was it a head fake and we are headed to better times? Now would be a good time to evaluate your philosophy and your strategy, to be prepared for either scenario.
So, why don’t we break down this buy and hold philosophy, the one that so many prescribe to. Let me begin by saying that I do believe that at times, individual stocks and mutual funds can be powerful tools to create wealth. Furthermore, the US equity markets are, for the most part, bullish over time. Historically, stocks provide investors with 6 to 8 percent average annual returns over the long term. But beware, the important phrase there is “long term.”
That is a dangerously vague time line. Does a 50-year-old, hoping to retire in the next 15 years, have enough time to let the “long term” take its course? Or, how about that 40-year-old hoping to pay for college for two kids in the next few years, can he or she hold on for the long term? Or how about that retiree; what does long term mean to him or her? With the market going up and down, if you can’t commit to the longest of terms (30-plus years), you might find yourself having to bail at a dangerous point in the ride.
Let’s think about that. If you plan to remain committed for the long term, you might want to check your resolve. While the buy and hold is a relatively easy strategy to stick to during a bull market, consider what can happen during a year like 2008, when the buy and hold strategy turned into the “cut and run” strategy. Many may think this happened when the market was down 10 percent, right? Nope.
Down 20 percent? You wish.
Unfortunately, in 2008, the average investor bailed when things were really looking grim, many taking losses of 50 percent or more.
Logically that doesn’t make sense, does it? Doesn’t the buy and hold philosophy stand for the idea that if you stick to your plan and have enough time, you should be able to take advantage of the market’s long-term growth?
Let me tell you about a study on investor behavior produced and updated annually by a respected independent financial research firm. The data from the study shows that the average American has not fared well in equity markets over the long haul. Although the average return for the S&P 500 has been around 7 to 8 percent over the past 20 years, the Dalbar study shows that the 20-year annualized return for the average American comes in at 2.5 percent and the 30-year return is even worse, a whopping 1.9 percent. You may be asking why, if the average investor bought and held his or her investment, didn’t he or she come close to the 7 to 8 percent average return?
Well, they should have, if they were truly loyal to their commitment to a long-term buy and hold strategy. But as I tell my kids, the greatest study in life is not how it should be, but how it is.
The fact is that human nature pits us against the buy and hold strategy because we do not have the resolve to watch our money dwindle away. We buy, we hold, then we hit the panic button at the worst of times, when our threshold for pain has far exceeded its limit. Unfortunately, for many that means we hit the panic button when our accounts are down 50 percent or more.
If we know we don’t have the resolve, or the time, to “buy and hold,” what can we do? There is a simple solution to this dilemma.
Why not build a defined risk on/risk off strategy, thereby helping to eliminate decisions that are based on emotions and opinions rather than facts, data and historical market trends? Why not create strategies that have specific rules that when the odds are in your favor you invest, but if the odds are not in your favor, you sit on the sidelines? And why isn’t the mainstream financial industry helping the average American with that strategy?
Hmm. Well, that’s a discussion for another week.
My point is this. Ask yourself, after the most recent volatility, are we good for the next five to six years, or is it a precursor to what is to come? No one knows with 100 percent certainty. Regardless, now is the time for you to do a gut check. And if you have a buy and hold strategy, can you hold on for the long haul? Or are you like the average American who will bail at the worse possible time?
Now is the time to be honest with yourself.
Now is the time to be vigilant and to stay alert, because you deserve more.