Not Enough Time to Buy And Hold

Successful investing means managing the long run and the short run

Market commentator and analyst Barry Ritholtz has recently posted on his blog about the big divide between the pundits and the public over the state of our economy. Or, as he puts it, “the disconnect between reality and the Pervasive Pollyannas of Prosperity.” Most of the analysts you see on CNBC, he says, are touting the strength of the economy, or at least its potential to turn around soon. The public, he says, sees the situation very differently – they’re expecting more rough seas ahead.

Barry says the pundits have just gotten ridiculous:

How absurd has the Panglossian cheerleading become? On my pal Larry Kudlow's show last night, several of Candide's descendants talked about how great stocks are if you hold them for 30 years. That's right, the holding period for equities according to this crowd is three decades. Of course, this means every pullback is a buying opportunity. Words such as these can only be spoken by someone who has never worked on a trading desk or managed assets professionally -- or if they did, they lost most of their clients' money.

Barry illustrates very clearly here the problem with the strategy of buy-and-hold. It’s true that the U.S. stock market has returned on average 10-12% annually over long periods of time. To take advantage of the long-term growth, you’d need to buy when the market is down. To a buy-and-hold investor, the current market downturn is a perfect buying opportunity.

But investing isn't just about knowing when to buy. The problem with buy-and-hold isn’t the “buy” part. It’s the “hold.” To get the long-term 10-12% return, you potentially have to hold for a really, really long time.

The Wall Street Journal is calling this "The Lost Decade." From Dec. 31, 1999 to December 31, 2007, the return of the U.S. stock market was practically zero (1469.25 in 1999; 1468.36 in 2007). Here we are in the middle of 2008, and the S&P is below 1300. For us to get back to the 10-12% average, we would have to experience a very long period of above-average returns. The question is, how long? Nobody knows. It could take 10, 20 years or longer. History tells us there have been 20-year periods in the past where the average return of the stock market was less than 2%.

If you’re in your 50s, your retirement time horizon may be 40 years (10 years pre-retirement; 30 years in retirement). 20 years is a long time to wait for the market to even itself out.

That’s why buy and hold doesn’t work for most of us. We don’t have time for it!

This is precisely why I am a cash-flow investor. My goal is to exchange the long-term 10-12% annual returns of the stock market for something more tangible in the short-term. If I focus on generating cash in the short run, the ups and downs of the market over time don't tend to bother me as much.

I admit, investing in the stock market this way is a bit of a paradigm shift. You have to think of your stocks not as an appreciating asset, but as a means to an end. Once you view your stocks this way, it’s a little easier to endure the market slowdowns.  

SOURCES:
1. Ritholtz, Barry. "Persuasive Pollyannas of Prosperity," The Big Picture, 02 July 2008.

2. Browning, E.S. "Stocks Tarnished By 'Lost Decade'," The Wall Street Journal. (accessed 02 July 2008)

Kim's Office Hours Return Next Week

Kim's travel schedule has struck again! No Office Hours this week, but they'll return next week at the usual times. Join her on Wednesdays from 5 p.m. to 6 p.m. or Thursdays from Noon to 1 p.m. (Central Time).

Kim will start each session with a brief presentation on a frequently-asked-about topic. Next week, she'll talk about the "Math of Withdrawals." Afterward, she'll take your questions.

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