The Globe and Mail

  The buy-and-hold mantra is a fool's game, our contrarians say.


Saturday, June 24, 2000

As stock markets and techs in particular took a beating recently, many investors stuck to their chops. What? Me worry? Markets always come back. Besides, most experts and financial advisers agree that buying and holding is the best way to achieve excellent long-term returns.

Think again.

There's a major difference between practising patient, long-term investing, which we advocate, and buying and holding. The former involves purchasing a position and selling it when either a target price is reached or the corporate fundamentals deteriorate and a sale makes sense. The latter suggests passing the stock to the grandchildren.

Buying and holding favours the firms and brokers receiving various and sundry fees from their clients. This trailing revenue provides a major source of earnings generation for these parties. While the average mutual fund fee of 2.2 percent might not sound like much, it's huge for the firms managing billions of dollars.

It's in their best interests to promote buy and hold ad nauseam as many do. Convincing the public to buy and hold becomes doubly critical when markets fall, because money under management declines dramatically. When this is compounded further by redemptions, brokerage firms and mutual fund companies start hurting.

One of the funniest reasons many experts advise against selling during good times is that clients will be dinged by capital gains. This is like suggesting succulent food should be avoided because you'll want it all the time!

Capital gains represent success. Taking an ample profit and paying the tax authorities is actually a reason to celebrate. This isn't to suggest that one should not attempt to minimize taxes. Smart financial planning to keep more bang in your pocket is fiscally wise. But holding onto a stock position that's fully or overvalued to avoid paying taxes means gains will eventually be eroded. Beware of advisers who suggest holding ad infinitum to avoid cashing in your winners.

Part of the specious logic underlying the buy-and-hold belief system is that many stocks never reflect their full value. The price of a stock should continually increase irrespective of previous gains -- otherwise why hold it.

Even if this were true, an investment must be considered relative to the risk-reward ratio of other possibilities. If tremendous success has been had with one position, odds are that it should be ejected from the portfolio and another with better potential scooped up. Perpetual holding is part of the reason for the regression to the mean that hampers most mutual funds and a large proportion of investors, as they stick with the tried and true.

Another false notion relating to buying and holding is that by going against this mantra, investors are practising market timing. There is nothing the matter with buying in when markets appear undervalued or eliminating a position when markets feel overheated.

In fact, panicking, especially if this is done before the crowd, is an intelligent move. This is something that we did in 1997 as our positions in Asia and Latin America were liquidated. Approximately 80 percent of our portfolio in these regions was ejected in January and August of that year, simply because those regions seemed overstimulated. Many of our colleagues queried, "Why sell when things are so good?"

Uhmm, because the party cannot last forever. Selectively choosing specific moments to buy and sell is far different than constantly moving in and out of different positions.

Not convinced, yet? Well, assume you bought near the peak in 1929 and decided to hold. If the basket of stocks had an average return, the investments would have treaded water towards the end of 1944. Perhaps that time frame is too remote to be considered applicable. Take the decade and change from 1969 to 1982, another period when buying and holding was for the most part, a suckers game, and stocks went back as much as forward.

Of course, if both of these durations appear short to you, then assume that some elitist stocks are the only investments in the world that never reach their full value. Then buy and hold until perpetuity is just around the corner.

Make certain the company purchased is an exception that people hold up to prove the rule like General Electric Co. or McDonald's Corp. Otherwise, buying and holding is a fool's game.