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Wisdom of Buy and Hold Questioned:

It's not much of a stretch to question traditional equity investing logic during deflationary market environments. In this article, Mike Dever and John Uebler, authors and quantitative researchers provide a robust case for same.

Tuesday, July 31, 2012

Top-Selling Industry Author

Wisdom of Buy and Hold Questioned

By Mike Dever and John Uebler

In 1999, global stock markets were at the peak of an 18-year secular bull market. Buy-and-hold had become a mantra. That˘â‚¬â„˘s no big surprise. At that time, there was no doubt that a person who had bought and held U.S. stocks (NYSEArca: SPY) over a long period would have made more money than in almost any other investment. But that belief was nei‚­ther rocket science nor sound invest‚­ment ad‚­vice. It was merely a simple ob‚­serva‚­tion. Yet books, articles, and investment semi‚­nars, by the truck‚­load, were produced that expounded on the benefits of buy-and-hold.

˘â‚¬Ĺ“For many people the validity of the buy-and-hold‚ myth has shriv‚­eled, along with the values of their stock portfolios.˘â‚¬ť - Mike Dever

For many people the validity of the buy-and-hold‚ myth has shriv‚­eled, along with the values of their stock portfolios, through‚­out the secular bear market that began in 2000. For many oth‚­ers though, the buy-and-hold approach continues to be a rally‚­ing cry and is con‚­tinually touted as being a vir‚­tue and the ul‚­timate strategy. However, buy-and-hold is not a viable strategy at all; it is merely a way to rationalize losses.

Let˘â‚¬â„˘s first review the historical results upon which this myth is based (using data pro‚­vided by Robert J. Shiller, author of the bestselling book, Irrational Exuberance 1).

Returns of Buy-and-Hold Strategy
U.S. Stocks Since 1900 2

Since the start of 1900, U.S. equities produced a real average an‚­nualized return of 1.82% if dividends were spent, rather than rein‚­vested, and a 6.27% real annualized return with divi‚­dends rein‚­vested. The ˘â‚¬Ĺ“real˘â‚¬ť return‚ adjusts the performance for the negative ef‚­fects of inflation, which reduced the returns by more than 3% per year on average. If we were to look at the ˘â‚¬Ĺ“nominal˘â‚¬ť return, the amount stocks earned before adjusting for inflation, the returns jump to 4.92% if divi‚­dends were spent and 9.51% with dividends rein‚­vested.

We are showing the returns both with and without the reinvestment of dividends to stress the importance of rein‚­vesting dividends. For various reasons, such as the fact that people are taxed on dividends and want to have the money available to pay taxes, many people do not re‚­invest their divi‚­dends. As the data in the table above show, over time, this neglect will cost them the vast majority of their cumulative profits.

On the surface, the nominal return, with dividends rein‚­vested, seems to fit the definition of ˘â‚¬Ĺ“healthy.˘â‚¬ť Someone plac‚­ing $100 in U.S. equities at the start of 1900 and holding tight for the next 111 years, reinvesting all dividends, would see their portfolio grow to a stunning $2,383,810 by the end of 2010. It clearly demonstrates the power of compounding, which Albert Einstein‚ said was one of the greatest human creations he had known.

Even after adjusting for inflation, the ending value of this portfo‚­lio is $85,598. This is still an outstanding return. Taxes would reduce these returns further but are not included in these cal‚­culations due to their ever-changing nature and vary‚­ing impact on each person.

What is obvious from the data, however, is that the major‚­ity of the real returns‚ did not come from stock price apprecia‚­tion, but from dividends. If, rather than reinvesting the divi‚­dends, a person spent them instead, the real value of the port‚­folio at the end of 2010 ˘â‚¬â€ś 111 years later ˘â‚¬â€ś would be only $744.

The chart below illustrates the real (inflation-adjusted) growth in an initial $100 placed into a basket of U.S. stock at the start of 1900, assuming dividends are spent and not rein‚­vested. This will undoubtedly concern people who have been told, as long as they˘â‚¬â„˘ve been alive, that stocks work best over the long-run. The most interesting observation here is that it took until 1950 before the value of the initial $100 ex‚­ceeded and stayed above that $100 value.

Growth of $100 Placed into U.S. Stocks in 1990

Real Returns ˘â‚¬â€ś Without Dividends

This means that for more than 50 years any person who placed $100 into a broad basket of U.S. stocks (such as NYSEArca: IBM, NYSEArca: KO, NYSEArca: CAT, NYSEArca: JPM) and who did not reinvest his or her dividends, would have suffered a loss, al‚­lowing for inflation. This really does give new meaning to the term ˘â‚¬Ĺ“long run.˘â‚¬ť

However, perhaps even more is the fact that all of the real stock market re‚­turns earned over the past 111 years can be attributed to just an 18 year period ˘â‚¬â€ś the great bull market that began in August 1982 and ended in August 2000. Without those 18 years the real, in‚­flation-adjusted re‚­turn of stocks, without reinvesting divi‚­dends, was negative!

This highlights the greatest risk of the buy-and-hold strat‚­egy, which is that stock market returns are extremely ˘â‚¬Ĺ“lumpy˘â‚¬ť.‚ 
This article is excerpted from Myth #2 of ˘â‚¬Ĺ“Jackass Investing:‚  Don˘â‚¬â„˘t do it.‚  Profit from it.˘â‚¬ť by Michael Dever.

About the Authors:
Michael Dever is the CEO and Director of Research for Brandywine Asset Management, an investment firm he founded in 1982.‚  He is also the author of ˘â‚¬Ĺ“Jackass Investing:‚  Don˘â‚¬â„˘t do it.‚  Profit from it.˘â‚¬ť, which is the Amazon Kindle #1 best-seller in the mutual fund and futures categories.‚  John Uebler is a Research Associate for Brandywine Asset Management.‚  Please visit and‚ 

1. Robert J. Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000, 2005, updated). Data used in Shiller book and for S&P 500 Total Return performance available at: Retrieved February 14, 2011.

2. Shiller, ˘â‚¬Ĺ“Irrational Exuberance.˘â‚¬ť

Regulator News

News Item: On June 9, 2012 PFG founder and CEO Russ Wasendorf Sr. was found parked in his car outside the Cedar Falls, IA corporate headquarters in a suicide attempt.‚  In the car was a note where the futures industry executive confessed he had committed fraud for 20 years.

NFA takes emergency enforcement action against Chicago futures firms Peregrine Financial Group, Inc. and Peregrine Asset Management, Inc.
July 9, Chicago - National Futures Association (NFA) announced today that it has taken an emergency enforcement action against Peregrine Financial Group, Inc.‚ (PFG), an NFA Member futures commission merchant (FCM) and‚ Peregrine Asset Management, Inc.‚ (PAM), an NFA Member commodity trading advisor (CTA) and commodity pool operator (CPO) located in Chicago, Illinois.

NFA has taken the Member Responsibility Action (MRA) to protect customers because PFG has failed to demonstrate that it meets capital requirements and segregated funds requirements. NFA also has reason to believe that PFG does not have sufficient assets to meet its obligations to its customers.

Effective immediately, PFG and PAM are prohibited from soliciting or accepting any additional customer accounts or customer funds, except as margin for existing positions. Additionally, PFG and PAM are prohibited from accepting or placing trades for any customer accounts except for the liquidation of existing customer positions and are prohibited from distributing, disbursing or transferring any funds, including to existing customers, without the prior approval of NFA.
The complete text of the‚ MRA‚ is available on NFA's website (

This article was published in Opalesque Futures Intelligence.
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