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The Modern-Day Flaws of Buy and Hold

Proponents of the buy-and-hold strategy will often point to its past success, which is undeniable, but also immensely short-sighted. Predicting future success based on past performance is the kind of blind logic that caused the NASDAQ, dot-com, real estate, and credit bubbles of the past 20+ years. There’s no doubt that many markets move in cyclical patterns, but economics themselves have clearly evolved past the point of new start-up, multi-industry corporations that can be relied upon to stand the test of time and make sound, long-term investments.

Even the modern-day tech giants cannot be relied upon for steady growth. Consider the case of Cisco Systems (CSCO), known the world over as the ‘plumbing of the Internet.’ In 2000, CSCO was humming along at $81.75/share at the peak of the dotcom bubble. A little more than two years later, it had imploded, falling to $8.12 a share in October of 2002.

Buy-and-hold investors could have easily decided to stick it out, reasonably predicting that the Internet was a fixture of the present and future worlds, and that statement was correct, but CSCO has never even sniffed that high-water mark again. Twenty-three years after its peak, it’s still trading below 2000 levels.

That sort of behavior is a staple of the S&P 500, which is where most buy-and-hold strategies come from. Bear markets, categorized by periods where the S&P 500 falls by at least 20% in value, occurred 15 times in the 80-year span between the crash of 1929 and the Great Recession of the last decade.

On average, it has taken the market 3.9 years to return to a break-even position, which means a buy-and-hold investor is not losing just money, but time, the true irreplaceable commodity. What’s worse is that there is another bear market an average of every five years after the last, meaning the theoretical buy-and-hold investor would have about a year to start building up earnings following one recovery period before plunging down into another valley.

There are some investors out there who believe that they have “good stocks” and their strategy should be to simply “grit their teeth” and they’ll be able to hold on and survive through a bear market. Unfortunately, the odds are decidedly against that idea; statistics show that in a bear market, just 3-6% of equities are able to swim upstream against the current. In other words, if you’re feeling really lucky, go ahead, but it’s not a smart bet.

Andrew Lo, director of MIT’s Laboratory for Financial Engineering, put it as bluntly as possible in a Money Magazine interview: “Buy and hold doesn’t work anymore. The volatility is too significant. Almost any asset can suddenly become much more risky. Buying into a mutual fund and holding it for 10 years is no longer going to deliver the same kind of expected return that we saw over the course of the last seven decades, simply because of the nature of financial markets and how complex it’s gotten.”

Lo isn’t the only leading economist preaching the unreliability of stocks, either. Yale University’s Dr. Robert Shiller, creator of the cyclically adjusted price-to-earnings (CAPE) ratio, warns of diminished returns in the future, based on prices divided by 10-year average earnings.
Warning of retracements for the Dow Jones and S&P 500 of as much as 30 percent, Shiller said, “”Nobody can really forecast the market accurately. But I think this is a risky time.” The uncertainty does not just stop at the edge of the United States’ borders, either. Macroeconomic conditions the world over make the buy-and-hold policy a risky one.

According to the World Bank, global growth continues to head in the wrong direction. “More than 40 percent of the world’s poor live in the developing countries where growth slowed,” said World Bank Group President Jim Yong Kim.

A lack of steady growth and fractures in countries whose economies have been traditionally strong makes many types of long-term investing risky at best. A weakened US economy has ramifications all over the world because of its many trade partners and allies.

China has grown at a breath-taking clip (although that is starting to weaken) and with that growth is accumulating its own massive amounts of debt. No country in world history with a debt build-up as large and rapid as China’s has ever experienced a soft landing. The country is already seeing signs of growing pains as its rural and urban populations veer in different directions with different wants and needs. China also holds large amounts of the current US debt, the most of any foreign country.

While the 28-country European Union (EU) is ostensibly powerful due to the idea of strength in numbers, the EU is only as strong as its weakest link, in this case the debt crisis that has plagued it since 2009 due to the inability of Greece, Cyprus, Portugal, Spain, and Italy to pay off debts or refinance them without the assistance of third parties. The debt crisis is a three-prong problem, consisting of debt, deflation, and demographics.

Even in markets like oil where long-term demand is all but guaranteed, the possibility of upheaval and massive fluctuations is a risk, as was seen in the so-called Arab Spring of 2010 as the leaders of Egypt, Libya, Tunisia, and Yemen, were all ousted, and sweeping changes and reform were demanded in countless other Middle Eastern countries that are part of the oil supply complex. Oil is a precious commodity, but also a fickle one. The price of one barrel of oil was $110 in 2014, then plunged to $26 in 2016 and actually traded below zero for one day in April 2020!

Likewise, natural disasters can cripple even the strongest of economies, as has been brutally evidenced in Japan by the combined earthquake and tsunami that caused the catastrophe at the Fukushima Nuclear Plant in 2011. One of the world’s largest economies before the incident, and still owning 7.0% of the US’ national debt, Japan has been forced to import 90% of its energy needs after the disaster, with an estimate of some $250-500 billion in economic losses in the time span since, with the potential for even more huge losses ahead, as the reactor and surrounding nuclear storage facilities are still not completely safe and secured. Japan has experienced suboptimal growth ever since 1989 despite a series of governmental stimulus attempts including monetary expansion and negative interest rates.
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