Analyze the Buy-and-Hold Market Strategy

Physician's Money DigestJanuary15 2005
Volume 12
Issue 1

Physician-investors are constantly told that tosucceed in the stock market, they should buyand hold a well-diversified portfolio of stocksfor the very long run because its risk supposedlydeclines over time and in the long run it provides higherreturns than any other investment.

While buy-and-hold investing may still be your bestbet if you are investing on your own, you should knowthat even when held for the long run, stocks are veryrisky investments and good returns are not guaranteed.

Better Approach

Consider the following two facts about the stockmarket and human nature:

• Because the stock market is driven by fear, greed,and other investor sentiments, at times it gets irrationallyexuberant and wildly overvalued, and at other times itgets inexplicably depressed and grossly undervalued.

• Even the most ardent devotees of the buy-and-holdstrategy generally sell out near the bottom of abear market because by then they cannot stand thepain and fear anymore.

Hence, it is clear that it can be highly risky and dangerousto buy into or try to hold through a grossly overvaluedstock market, as we saw in the late 1990s.Instead, if you partially get out of the market or just stopputting in new money at those times and have thecourage to buy back in when the market gets verydepressed, you will significantly lower your risk and earnhigher returns. This is the approach that most successfulvalue investors follow. They buy low and sell high,whereas most investors buy high and sell low.

This approach is different from conventional markettiming, which generally does not work because itrequires impossibly precise timing. The stock marketgets grossly over- and undervalued only in cycles ofyears, which provide ample time and wide price rangesto follow the suggested approach.

Problems for Retirees

Physicians who are approaching retirement or whoare already retired and try to follow the buy-and-holdstrategy face two additional problems. First, they may nothave enough time for the market to reward their faith.They are also more likely to get scared and sell out nearthe bottom of a bear market after losing a big part of theirsavings, thus jeopardizing their retirement security.

Second, buying and holding during retirementrequires selling a mix of stocks and bonds every year tocover living expenses, irrespective of market conditions.Complex mathematical reasons, such as reverse dollarcost averaging, can reduce the actual return of a retirementportfolio to as low as 50% of the market's return.Therefore, for retirees, buying and holding can significantly increase the chances of running out of money yearsearlier than expected—the retiree's ultimate nightmare.

Market Challenge

The challenge, of course, is to be able to judge whenthe market is grossly over- or undervalued. What's more,an overvalued market can remain overvalued or keep risingfurther for months or years, which is what happenedin the late 1990s. So, following the suggested betterapproach takes a lot of knowledge and unshakable conviction,discipline, and patience. It is very difficult to stayout of a market and look stupid for months and yearswhen everyone else seems to be minting money andlooking like geniuses.

Conversely, getting back in when the marketbecomes grossly undervalued is equally difficult, becauseat those times everything looks bleak. The market canremain grossly undervalued for months or years and testthe limits of your courage and patience.

Try to find and work with an experienced andknowledgeable investment advisor who follows buyingand holding, but also knows how to circumvent its pitfalls.You can't afford not to act rationally when yourown money and financial future are on the line.

author of The Only Proven

Road to Investment Success (John Wiley; 2001)

and Financial Modeling Using Excel and VBA

(John Wiley; 2004), currently teaches finance at

the Fordham University Graduate School of

Business and consults with individuals on financial

planning and investment management. He welcomes

questions or comments at

Chandan Sengupta,

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