Stock traders and brokerage houses looking for trading commissions love to deride “buy and hold” investment strategies. They use market downturns like the recent bear market to “prove” their points: that smart investors could have sold out of growth stocks in 1999 or 2000 and avoided the subsequent carnage, while getting back in early this year in time for the upswing.
This is a tired argument heard after every market crash from a crowd that benefits from investors who churn their portfolios. Their justification usually rests on an exaggerated and naive buy and hold strategy, one where an investor buys a non-diversified, irrational portfolio and holds it forever.
A rational investor who adheres to a well thought-out buy and hold strategy should have a much better chance of succeeding than the critics suggest. Such an investor would define his investment objectives, set up a diversified portfolio to meet those objectives within a specific time frame, and rebalance the portfolio periodically to adhere to its original diversification.
Such a strategy avoids having to predict the market—a feat that academic investment theory suggests is not possible. The best research shows that a trader trying to time the market has to be right more than three-quarters of the time, and has to call markets bottoms and tops pretty closely. The evidence suggests that few, if any, professional investors have achieved this level of timing accuracy.
Buy and hold investors, meanwhile, avoid having to make short-term emotional decisions. Their diversified portfolios don’t suffer too badly when one part of the investment universe does badly, and they participate in the long-term growth of the economy, which helps to make up for short-term paper losses.
Rebalancing is an important part of a buy and hold strategy. By leaving a portfolio untouched for many years, asset classes tend to get out of balance. The stock portion, for instance, may grow to be much greater than the original allocation, exposing the investor to more risk in the next, inevitable bear market. A judicious rebalancing plan that does not subject the portfolio to frequent changes can help keep risk levels in line and lead to long-term success.
