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Friday, November 19, 2010

Buy and Hold : Don't Bury It Yet

I truly had planned to write an article on this subject inspired (sic) by articles like this one in the weekend WSJ that proclaimed       and by the profusion of new mutual funds designed to "make money in up or down markets'. But the esteemed Prof Burton Malkiel beat me to the bunch in a great article in the WSJ today. If you read one article about personal investing this year this is the one to read. I may have some quibbles and implement slightly differently but no one could go wrong following the advice.

from the article:

Many obituaries have been written for the investment strategy of buy and hold. Of course, investors would be better off if they could avoid being in the stock market during periods when it declines. But no one—either professional or amateur—has ever been able to time the market consistently. And when they try, the evidence shows that both individual and institutional investors buy at market tops and sell at market bottoms.
Money poured into the stock market at the peak of the Internet bubble during the first quarter of 2000. Stocks and mutual funds were liquidated in unprecedented amounts at market bottoms in 2002 and 2008. Professional investors had large cash holdings at market bottoms but tended to be fully invested during market tops. Buy and hold investors in the U.S. stock market made an average annual return of 8% during the 15 years from 1995 through 2009. But if they had missed the 30 best days in the market over that period, their return would have been negative. Market strategists called for a sharp market decline in late August 2010 as technical indicators were uniformly bearish. The market responded with its best September in decades

A few key points Malkiel makes, several of which I have made in the past in making the case for a diversified portfolio of low cost index funds or etfs.
  • Diversification does work no investor should be 100% US stocks
  • Investors should have  a good sized allocation to emerging markets
  • There is a rebalancing premium over a period of 1996 - 1999 was between 1 and .33% a year
  • Even in the "lost decade" of the 2000s a well diversified portfolio rebalanced would have generated posiitve returns. His sample portfolio is graphed below vs 100% stocks.
  • Timing can be devastatingly costly. Missing only a few trading days can cut massively into long term returns.
He concludes:

The chart nearby illustrates how someone who invested $100,000 at the start of 2000 and, following my advice, used index funds, stayed the course and rebalanced once a year, would have seen that investment grow to $191,859 by the end of 2009. At the same time, someone buying only U.S. stocks would have seen that same investment decline to $93,717.
The recommended index-fund portfolios contain bonds, U.S. stocks, foreign stocks (including those from emerging markets) and real-estate securities. The diversified portfolio, annually rebalanced, produced a satisfactory return even during one of the worst decades investors have ever experienced. And if the investor also used dollar-cost averaging to add small amounts to the portfolio consistently over time, the results would have been even better.
If you ignore the pundits who say that old maxims don't work and you follow the time-tested techniques espoused here, you are likely to do just fine, even during the toughest of times.

Malkiel's Graph

I ran some numbers on a portfolio of indices with a 65/35 stock bond mix and a globally diversified stock portfolio with a tilt toards value stocks small and large. Not surprisingly my results also did not spell the end of buy and hold.
Ten Year return rebalanced annually 5.8% annualized return $100,000 would have grown to $181,000

without the rebalancing the return was cut to 5.13% with a final value $169,000

As for the recent "disaster years" for buy and hold an investor with an etf portfolio that rode the roller coaster since Jan 0f 2007 would be positive for his portfolio with $100,000 intiial investment worth $106,900 The chart compares the portfolio (green) with the 100% sp 500
The investor who had "given up" and gone 100% tbills would see an account balance of $102,100

Perhaps not a big difference but remember this was a "black swan" three years and the buy and hold investor did better.

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