Jan 14

Buy-hold strategy may have had its day…I don’t think so

Page 31 of the Australian Financial Review (AFR) today has an article suggesting “that the traditional buy-hold approach to owning shares is dead”…full text, with subscription can be found here. The article’s stated reason for buy-hold is that “in the long run, markets always go up and will provide investors with a good return on their investment as well as tax benefits, despite any volatility”.

Unfortunately, financial planners are placed in a dim light as usual, with ignorant comments like, “The buy-hold strategy is often sold by financial planners because it requires less management work – helpful for those with a large client base – as stocks selected are held for many years”.

Whilst there is a little bit if truth in each of the above statements, unfortunately the main reason behind the buy-hold strategy is ignored altogether. That is, that timing markets is very very hard and after transaction costs and potentially other costs are taken into account, there is more evidence to suggest that buy-hold is a far more successful method of achieving sharemarket returns than active management. This belief has the foundation in numerous academic articles, most notably Brinson, Beebower and Hood’s “Determinant of Portfolio Performance”, and the consistent failure of active managers to outperform benchmarks (see recent SPIVA results).

Unfortunately the AFR article suggests that in order to be successful at beating the buy-hold approach,  signals such as momentum, timing markets (good luck!) and the ability to pick ‘high-quality’ companies using certain factors is all you have to do. If only it was that easy.

For the individual investor, picking stocks is largely a mug’s game…sure you might beat the market but I can pretty much garantee it will typically be more through good luck than any demonstration of skill and any outperformance will probably come from taking on more roisk (even unknowingly).

Personally, I like the idea of being dynamic with regards to investment portfolio. My approach is a little different and is based around designing portfolios to accept or not accept various macro risks…the likelihood of underperformane must be accepted and outperformance will never be guaranteed like some of these fund managers market but rarely live up to.

Bottom line…there is no silver bullet but the most efficient way to receive sharemarket returns will be via a very cheap index fund…and that is a buy-hold strategy and a very popular strategy of financial planners and for good reason.


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1 comment

  1. BB

    The AFR at it again, whats a retail investor to do??

    Nothing wrong with “Buy & Hold”, if you understand the risks and truly have the time horizon. I always understood the “hold” part to be derived from the assumption that you have purchased an asset to which you have sufficient confidence in its underlying value (i.e probability of producing a given long term return). You are then willing to “hold” that position regardless of market movements provided your confidence in the assets ability to generate that return remains constant.

    This is distinctly different from buying any asset, asset market (or mix of) at any price, at any time simply based on the premise that regardless of its current fundamentals it will generate a positive return over time (affectionately sold as “the average long term return”). This strategy is more accurately known as “buy and hope”.

    The later is frequently confused with the former and (in my experience at least) its the one we all happen to be paying $$ for (whether its your friendly industry super fund investment committee or your local branch financial planner)

    Of coarse the AFR article fails to get the point and I agree that it’s “strategy” as implemented by your average investor has a lower probability of decent returns that even buy and hope!

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