Following a rare decade in which bonds outperformed stocks, many of the talking heads are declaring dead the tried-and-true strategy of buying quality companies and holding them for long periods of time. I emphatically disagree. The "buy-and-hold" investment strategy, espoused by such renowned investors as Warren Buffett and Benjamin Graham, has never been more relevant, in my humble opinion. (Buffet's Berkshire Hathaway is up over 80% over the past 10 years.) In an era that has become characterized by irrational exuberance, bubbles, and instant gratification, it is more important than ever to maintain a strict discipline in one's investment process. The alternative - abandoning fundamentals in favor of quick profits - has never been able to produce consistent investment results over time.
We have all seen over the past decade how following the herd can result in devasting consequences. First it was the technology bubble, then the housing bubble, then the commodity and credit bubbles. Each time the pundits told us that "this time it's different", or that we are experiencing a "paradigm shift." While outsized profits were indeed realized by many during the course of these bubbles, countless more were left without a chair when the music stopped playing. The point is this: adherents to a momentum investing strategy make one enormous faulty assumption - that we are able to time the market turns with some degree of precision. We at Farr, Miller & Washington are not so arrogant to believe we know how the markets will behave in any give day, week, month or year. Moreover, the consequences of missing out on massive and unpredictable market rallies can be devastating to long-term portfolio returns.
Consider the following:
H. Nejat Seyhun, professor of finance at the Ross School of Business at the University of Michigan, studied an index of US stocks over the period 1963-2004. While the index gained 10.8% per year, the annual return would have been just 3.2% if he had removed the 90 biggest-gaining days. Furthermore, less than 1% of the trading days accounted for 96% of the market gains.
Javier Estrada, a professor of finance at the IESE Business School in Barcelona, performed a study of equity markets in 15 nations, including the US. His conclusion was that a portfolio missing the 10 best days over several decades ended up, on average, with about half the balance of a portfolio that missed no days.
An October 13, 2008 Barron's article by Jacqueline Doherty looked at US stocks from February, 1966 through May, 2007. Doherty concluded that a $10,000 investment would have grown to $165,800 over this time frame - a 7% annualized return. However, investors who were out of the market in the five best days each year during that span were left with only $1,100.
Let me be clear.
Buying junk and holding junk has never worked. Investment decisions must be made with strict adherence to the fundamentals and enormous attention to valuation. If nothing else, my experience has taught me that quality, time and discipline mitigate risk for investors. Having said that, hindsight would teach us that buying any stock at the market highs in the year 2000 was probably not a wise thing to do. Therefore, a successful buy-and-hold strategy requires that we not only buy quality companies, but also that we make sure that we are paying attractive prices. In other words, don't mistake a great company for a great investment.
In conclusion I would say that one can always find a defined period of time when any investment strategy does not produce the desired results. The last ten years is one of those periods for the buy-and-hold strategy. However, finding an outlier period of weak performance is not sufficient to invalidate this very successful investment strategy. This is the third time in the last 100 years or so when markets have underperformed for this long, and each has been followed by periods of well above-average returns. Moreover, those claiming that buy-and-hold is dead have failed to provide a more successful alternative. The bottom line is that the long-term trend in the equity markets is up, and by buying quality companies and holding them for long periods of time we seek to benefit from this trend. While the last ten years has been disappointing, we are comforted by the fact that historical returns following periods of such weakness have been excellent. So stay the course and drown out the noise!