‘Buy & Hold’ – Ifs & Buts

‘Buy & Hold’ is a passive investment strategy in which an investment is held for a long term, regardless of fluctuations in the market. As owner of businesses, investor creates wealth through compounding of superior returns, without getting distracted by volatility of stock markets.

‘Timing the Market’ is tactical asset allocation strategy in which equity is sold when market valuation is considered expensive (or has lost momentum) & re-invested into when valuations become cheaper (or has gained momentum).

The case for ‘Buy & Hold’ Strategy is made out on the basis that stock market is directionally upward biased, on account of its link to corporate profits. Economic growth & efficiency of businesses finds reflection in rising profits & stock markets are thus structurally primed to move to newer heights. Any negative volatility along the way, is sure to be overcome by positive volatility that follows. Random Walk Theory states that past movement or trend of a stock price / market cannot be used to predict its future movement.

‘Buy & Hold’ strategy discounts any benefit of timing the market (avoid the downturn & reinvest in the upcycle), as it is impossible to outperform market without assuming additional risks. It is important that investors not fall prey to overconfidence bias that prompts them to overestimate their ability to forecast the trends of stock market & therefore time the market. The strategy holds that it is not possible to consistently add value to portfolio returns by doing so.

Uncertainty, possibility of unknown risks & luck plays an important role in progress chart of every investment. This presents many technical & behavioral challenges to successful timing of the market. Staying invested is no different although it poses a different set of technical & behavioral problems. ‘Buy & Hold’ investor keeps investing through bearish phase, waiting for a big year with bumper returns. Is this not timing by indirect means? Basing the investment strategy on the assumption that market has to go up, is not without inherent dangers.

Historical data of stock markets is put forth to support the efficacy of this strategy by showing that markets have generated strong compounded returns despite regular bouts of negative volatility. Also, that bull markets are characterized by many intermittent falls & bear markets too witness strong upward movements within the downturn. The opposing short-term counter moves & pervasive uncertainty of the market, could be a trigger for an investor to stay out of the market & thus make him lose more waiting for the correction than what he would otherwise lose by the correction itself. ‘Buy & Hold’ strategy absorbs the pain of downward correction while capturing the complete gain of secular economic growth. 

No doubt Nifty 50 index has moved from 1000 in November 1995 to 17583 as on 24th Sep 2021 @ CAGR of 11.46%, (excluding dividend).

It is also true that

  • Nifty 50 Index gave NIL returns between financial year end of 1995 & 2003 – 8 years. Is this short term, medium term or long term?!? It is important not to shift expectations with different sets of data.
  • 10-year SIP in Nifty 50 index (incl dividends) as on 23 March 2020 (Nifty 50 @ 7610) produced XIRR of 1.69%.
  • 14-year SIP in Nifty 50 index (incl dividends) as on 23rd March 2020 produced XIRR of 3.76%.
  • Dow Jones Industrial Average reached 919 in May of 1968, & by August of 1982, had fallen to a level of 777, for a loss of 15% in 14 years. The real value of the Dow drops to 274 if we consider purchasing power of Dollar (35 cents to a dollar in 1968), then stock portfolio is down by a staggering 70%. 

Secular bear markets are entirely real, they are the reality of history. It is the idea of a bear market being a brief & reliable buying opportunity that is myth, over the long term & needs to be reassessed.

‘Buy & Hold’ strategy places a huge premium on the magic of compounding to eventually compensate the negative returns of bear phase. One needs to appreciate the limitations of compounding & risk that come with blindly believing that it works in all situations. An investor cannot afford to ignore ‘Sequence of Return’ risk in his financial planning. This risk comes from the order in which investment returns occur. The return – at the beginning of the period of investment &/or at times when large investment is put to work – carries more weight in the overall results. Same set of return percentages over an investment period but in different sequence, could produce very different outcomes. This is where the luck comes to play such a vital role in the investment process.

Warren Buffett is held out as a poster boy of ‘Buy & Hold’ strategy since he advocates holding onto good companies for eternity. Success of Berkshire Hathaway in compounding gains over so many decades, is held out as conclusive evidence of efficacy of this strategy. It needs to be remembered that his wealth size, knowledge & managerial bandwidth, stable behavioral impulses and participation in best period of American economic growth & political dominance (luck!?!) have played an important role & his success cannot be attributed to the strategy alone.

Buy & Hold’ is not an all-weather solution that it is made out to be but rather a strategy that should be used in certain circumstances & with certain caveats. Justifying a strategy of buying & holding in all market conditions, on basis of performance of indices that are actively managed, is quite an irony. The implication of this strategy that prices do not matter & investment can be held under all conditions, is a flawed investment philosophy. If the risk of buying & holding securities is not commensurate with the reward, under conditions that are mathematically assessed (& without benefit of hindsight), then it cannot be the case that higher returns be pursued with complete disregard for risk management.

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