One of the persistent themes on Wall Street is that investing strategies go in and out of favor on a regular basis. Oftentimes this has to do with the performance of the strategies, sometimes based on the structure of markets and always having to do with the media hype surrounding a strategy. Most strategies that reach the level of public consciousness are likely.
The fact of the matter is that even the most well-crafted investment strategy will have periods of underperformance. As Jeff Miller at A Dash of Insight writes:
Your system will not always work!
The most recent investment strategy to take its hits in the eyes of the public is “buy and hold.” This shouldn’t be all that surprising given the generally dismal performance of the US equity market over the past thirteen years, which for most investors is all they can remember. Given the volatility of the markets all manner of strategies that advocate various levels of active investing have been proposed to help alleviate the risks of continued exposure to the equity markets.
For instance one way that fund firms advocate to avoid the risk of buy and hold is tactical asset allocation. Unfortunately the results have not lived up to the marketing. Larry Swedroe writing at CBS Moneywatch notes that investors would have been better off in the most basic of funds the Vanguard Balanced Index Fund than in these TAA funds. He writes:
Bottom line: TAA fund investors incurred heavy fees because of the active management, and returns were poor. In short, we have another game where the winners are product purveyors, not investors.
David Merkel at the Aleph Blog in a couple of posts writes that the death of buy and hold is greatly exaggerated. In his first post he notes that the vast majority of investors are not built for trading:
The average investor is horrible at market timing. They buy high and sell low. The more volatile the asset subclass the more pronounced this behavior is. I have witnessed this personally while analyzing the return differences for Bill Miller, Bruce Berkowitz, and the S&P 500 Spider. There is a profound difference between the returns that a buy-and-hold investor receives, and that which the average investor receives. The buy-and-hold investor almost always does better; the only exception that may exist are value investors who have learned to resist price trends, painful as that may be.
Trading for the sake of trading, which is the consequence of what many investors do, is an ongoing problem. Merkel in a follow-up piece writes that investors have to have a strategic motivation for trading. In short, every trade must be in an attempt to upgrade your portfolio or “trade to improve.” Merkel writes:
Buy-and-hold is a fundamental strategy in investing. It presumes that you spent the time analyzing whether this asset was undervalued. If it becomes overvalued, it does not mean you should hold it. Always look for better relative value. In the end that leads to better portfolio performance.
The fact is that buy and was never “buy and forget.” At a very minimum an investor needs to revisit their portfolio on an ongoing basis to rebalance and assess their tax situation. Any sensible investment strategy also accounts for the fact that circumstances change. For example today we are in an period of extraordinarily low rates on all manner of Treasury securities. After taking into account inflation and taxes investors are almost guaranteed to lose real value over time investing in Treasuries. Investors should not accept this reality without some consideration.
Jonathan Burton at Marketwatch notes that there is a middle ground between hyperkinetic trading and “passive acceptance” of the markets. The challenge is coming up with a framework and strategy that works for you, because there will inevitably be periods during which your portfolio disappoints. Maybe Meir Statman sums it up best:
Trade to improve your portfolio, not to chase the market’s new hot roadster or avoid its latest monster…
Markets change. Our circumstances change. Every portfolio needs tweaking over time. However tweaking need not add up to trading. Trying to incrementally upgrade a portfolio avoids making the wrong decision all at once. Luckily for investors today we are now able to keep more of what we make. Don’t let a need to trade override the cold, hard math of the markets.
As soon as we pushed publish we saw this piece from last year by Mark Hulbert at the AAII Journal that talks about the idea of trading being a drag on portfolio returns. He concludes:
The implication, hard as it is to believe, is that the average transaction lowers portfolio returns. You don’t have to be a rocket scientist to draw the corollary: If the average transaction lowers returns, you ought to undertake as few of them as possible.
This doesn’t mean you should never, ever make any transactions. But it does mean that the burden of proof you should satisfy before you do trade is probably several orders of magnitude higher than you think.
In short, the idea of trading to improve may be a worthy principle, but one that still should be approached with a measure of caution.
Items mentioned above:
Jeff Miller, “Your system will not always work!” (A Dash of Insight)
Tactical asset allocation in mutual fund practice hasn’t added much value. (Larry Swedroe)
Buy-and-hold can’t die. (Aleph Blog)
Buy-and-hold does not mean hold a grossly overpriced asset. (Aleph Blog)
Speed kills, but so does complacency. (Marketwatch)
Keep more of what you make. (Abnormal Returns)
Think twice, even thrice, before trading. (Mark Hulbert)