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Written by: Jared Coffin
I've often come across articles and studies about the positive benefits or negative side effects of various products.
One year I'll read that a given product is good for you. Later, I may read a conflicting study that states this product is horrible and could seriously harm your health. Most of the time I know little about the subject so don't know what to believe.I find such articles and studies fascinating because they mirror headlines I read on a daily basis concerning the stock market. I often hear about the positives and negatives of certain investing strategies. They too change over time, based on new information and changing circumstances. Increasingly over the past few years, passive investing - specifically, buy and hold - is supposedly the only thing that works. By contrast, during more prolonged downtrends, tactical investors will come out to preach and praise the fact that they have side-stepped a portion of some downtrend.Before I go further, I want to state my belief that both methods can work - and many other strategies as well. What annoys me is those advisors and investors who bash a methodology that is different from the one they believe in. It can all work, depending on time frames and market conditions. Also, different strategies fit different personalities. While there are endless investment options, I want to focus on buy and hold. Again, I believe in this method of investing. Yet I don't believe it suits many investors.Throughout our current bull market, the passive investor has looked quite smart. The market has continued to move higher over a long time frame. In fact, it's the longest bull market in history. Whenever you are in the strategy that is currently giving the best results, it makes you feel good. And history has demonstrated that those investors that stuck with it long enough have typically done alright.My main argument against buy and hold is simple: Human behavior. Humans are incredibly emotional. The level of "pain" (e.g. portfolio draw downs) we believe we can endure, and what we actually can endure, are two different things. Now, I may be completely wrong, but I highly doubt that in the depths of the Great Financial Crisis of 2008 or in the Dot-com crash of 2000, the average investor was wanting to buy stocks hand over fist because they were at bargain prices. It's more plausible that near the bottom, when things looked hopeless, they were abandoning their buy and hold philosophy and selling everything they owned. I'm reminded of a famous quote and the title of a book from Wall Street legend Walter Deemer: "When the time comes to buy, you won't want to."The same arguments passive investors use to defend their approach can also be used against them. I've heard things such as, "Technical analysis and timing don't work." Markets are random, and past prices and patterns don't predict the future. However, if the past can't possibly help to predict the future, didn't you just discredit your entire thesis for passive investing? You are basing your theory that markets will be higher 10, 20 and 30 years from now because historically that is what has occurred. Yet, there's nothing to say that we won't sustain much lower prices over the coming decades. Do I know this is going to occur? Absolutely not. But by the same token, you can't tell me that you know definitively that the market will be higher. History has shown that it may take decades to eclipse previous highs, leaving many investors with decades of lost returns. I've provided three examples in the following images.May 2000 through May 2013
September 1968 through June 1982
August 1929 through August 1954
Obviously, in the images shown, some investors bought at rock-bottom, some may have dollar-cost-averaged, and others may have bought at the market peak. My point is simply to illustrate that over a long time frame, the market made little headway.Related: The Night is Dark and Full of Risk … Is Your Portfolio?In the following image, I've plotted the performance of the S&P 500 (SPX), Italy's Stock Market (FTSE MIB) and Japan's Nikkei (NKY). The period illustrated is May 1990 through May 2019. My purpose for comparing the returns over different periods is to show that markets don’t have to continue to rise over extended time frames. Many foreign markets have demonstrated this, as we can see from the FTSE MIB and NKY.
Source for all graphs: KoyfinIn the preceding images, I chose certain periods for illustrative purposes. However, you can look at multiple rolling periods throughout history and see that it's not a one- or two-time phenomenon. Depending on when you bought into the market cycle, you can look like a genius or can face decades of draw downs.I have nothing against buy and hold. If it suits your investing style, and you stick with it over time, it may continue to perform as it has historically. Yet, whether it's passive or any other style of investing, you need to make sure you can handle the stress associated with the method you've chosen. If you would like to find out more, click here.