Buy-and-Hold Can’t Die, Take II

Buy-and-Hold Can’t Die, Take II

Buy-and-Hold Can’t Die, Take II

David Merkel of Aleph Blog

When I wrote my piece last night, I did not write it to say one ought to buy and never sell.  In investing, I encourage the concept that one must look to relative valuations and trade assets that are worth less for those that are worth more.  In doing so, one maintains exposure to the overall risk of the markets, but shifts to more promising areas.

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But what if valuations get so strained that future returns from most risk assets are tepid?  At that point, buy-and-hold turns into sell-and-wait.  It’s like being a bond manager — if the excess returns are small from taking additional risk, you don’t take additional risk.

I tend to turn over my portfolio once every three years.  That to me is a good tradeoff between holding for a long time and recognizing that opportunity changes over time.  But my trading is driven by analyzing relative opportunity, selling what I think are lower future cash flow streams for larger cash flow streams.  Do I have a crystal ball to tell me which is better?  No, just business judgment.  As Buffett says, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”

My business judgment has done well for me over my career, but I don’t pretend that it is infallible, because I make significant mistakes.  Humility is an asset to the investor, because we don’t always know the right course.  That said, let diversification handle uncertainty, and within risky assets trade away less promising assets for those with more promise.

A reader wrote me, one who works for a prestigious university and he said:

Since 1926, the minimum inflation-adjusted total return of the S&P 500 (or its predecessor index) has been over 4%, annualized, over every 40-year rolling period.  For 20-year periods, the returns are typically either high (say 9%) or low (say 2%).  Thus, the buy-and-hold investor is best off with the 4-decade hold time.  Fortunately, 40 years matches the typical work life of a person, so workers ought to be shoveling retirement money into equities, and leaving there when they retire, if history is any guide.

 Your thoughts?

Yes, so long as your government holds together, over longer periods of time we do better.  But the tough part for retirees is “What is my situation like when I retire?  Yes, I built up a pot of assets, but what will that buy in terms of continuing income, and will that do well against declining purchasing power?”

There is no magic bullet.  I try to solve this by shifting industries over time, aiming at the most promising current opportunities, but not leaving the market in entire.  I limit cash to 20% of the portfolio when valuations are strained for he market as a whole.

Back to the question, yes, I think most people should buy-and-hold, if they can’t analyze the asset markets.  That’s like the Biblical proverb that a fool is counted wise if he is silent.  But for businessmen/investors there are often relative opportunities to do better.  Analyze those opportunities and take the best of them.

Yes, have some exposure to risky assets for your career, but vary the amount of exposure, and where it goes relative to likely opportunity.

I appreciated Jonathan Burton’s piece Speed kills, but so does complacency.  Like me, he is trying to strike a balance between hyper-trading and permafrost.

My mother is a good example here, though she does things differently than I do.  She holds stocks for a decade or so on average, and analyzes to see whether they have long-term prospects.   She buys, holds, and occasionally adjusts.  She spends more time painting, for which she has a degree of reputation.  She beats average asset mangers regularly.

The main idea should be one of relative value: trade to improve.  Look at the underlying cash flow streams if you can, and trade smaller for larger.

Here’s one more tool to help you.  When the amount of money into an asset goes parabolic, it time to leave.  It is rare that large amounts of additional money will yield excess returns.  This simply admits that there are times when it is wise to reduce exposure to risky assets.  just as bond managers look at yield spreads to commit capital, so should investors in risky assets aim for a margin of safety in what they invest.

As a final note, 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.

David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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