In our last post, we looked at a few commonly perceived negatives on the buy and hold investment strategy.
Some of the minor complaints.
Today we will review more legitimate concerns.
Buy and Hold May Not Provide Maximum Possible Returns
A buy and hold strategy is essentially as it states, you acquire an asset and hold it throughout the investment horizon.
Investment theory indicates that over time, on average, appreciating assets (such as equities) will increase in value. Granted, it may be a long time, but historically this has held true.
However, over the short and medium periods, there may be large price fluctuations in an asset. The greater an asset’s risk level, the greater the potential price swings.
If an investor can properly time the peaks and valleys of short or intermediate price fluctuations, the investor can sell high, then repurchase the same asset when it falls. This ensures the same position at the end of the investment time frame, but by selling and buying back the investor can profit on price fluctuations.
In short, the belief is that active management can outperform passive investing.
I would say that this is a legitimate issue for a buy and hold strategy.
Buy and Hold Does Not Protect in Down Markets
Markets, and the assets within a market, go through down cycles. Depending on the length of time, this may be called a crash, market correction, or possibly a bear market.
A buy and hold strategy sees investors sit tight during market descents. With some bear markets, this can wipe out previous accumulated gains and/or create portfolio losses.
Smart investors shift their assets in down markets into defensive positions or alternative asset classes that protect their capital.
Again, active management can protect portfolios during down cycles.
Another legitimate concern.
Buy and Hold Only Works if You Are Immortal
If you adhere to modern portfolio theory, you believe that in the long run, appreciating assets increase in value based on certain factors.
But that may require an extremely long holding period. One not all investors can maintain.
Many investors do not seriously begin to invest until they are in their early 40s. If they need to liquidate at 65, 20 years may not be a long enough time frame. Had you invested in the Dow Jones Industrial Average at its peak in 1929, it would have taken 25 years for the Average to recover after its losses in the early 1930s.
So one’s investment time frame is relevant to the potential success of a buy and hold strategy.
These three concerns are common when you read articles on buy and hold investing.
These concerns suggest that active management is better than passive.
But is it really?
We will consider the question more fully in my next post.