Buy and Hold Is Alive and Well

Since the most common pro-timing response I received raised the question, "So where has buy-and-hold gotten anyone since the bubble popped in 2000, huh?", let's get that out of the way first. The only "bubble" that popped was a large-growth/tech/dot-com bubble--which means that unless you were overloaded in the aforementioned asset groups, the past two years haven’t been nearly as nasty as the headline indexes would indicate. Although the Nasdaq is off more than 60% and the S&P 500 is down about 17% since March 2000, bonds are up about 20%, REITS have zoomed almost 40%, and both large- and small-value have also done quite well.

What all this means is that a diversified portfolio would have done a lot better over the past couple of years than overexposure to large growth and tech--though such a portfolio would have lagged the big indexes in the late 1990s. In other words, the lesson of the late-1990s bubble is not that "buy and hold" is dead, it’s that diversification and portfolio rebalancing are alive and well. The way to mitigate risk is to diversify your assets, not to try and guess when you should be in or out of the market entirely.

Whenever you start worrying that you're underperforming the other guy because he's put all of his eggs in one basket, just remember that what goes around, comes around. Over the long haul, a diversified portfolio will give you more bang (reward) for your buck (risk) than one that's loaded up in one asset class--or one that tries to hop in and out of the market based on some market-timing mechanism. Successful investing is about putting the odds in your favor, and market-timing doesn't do that.

Another common theme among the responses I received concerned the wisdom of shifting around assets to take advantage of temporarily under- or overvalued sectors or asset classes. As one reader wrote:

"It seems to me a sensible approach is to stay invested (so as not to miss the good days) but to move a bit when one sector seems to have run its course…. I'm a high-tech investor (retired from a career in it) and so my bias is to hold stocks there. I know the business, products, and companies. But I can also see when valuations are way out of hand and consistently pulled money out as the boom was raging. Some of the other (i.e. non-high-tech) issues had been languishing during the boom and were dirt cheap in valuations."

Although die-hard efficient-marketeers might disagree, I would wholeheartedly say that selling high and buying low isn't market-timing--it’s just good common sense. For the more passive investor, the easiest way to do this is to pick an asset allocation and stick with it, even though that means selling winners and buying losers. When an asset class gets more than 5% or so above your target allocation, trim back and plow the proceeds into areas that have been underperforming. The laggards comprise a smaller proportion of your assets, and they’re probably cheaper than the portions of your portfolio that have been rocketing ahead. Essentially, rebalancing your portfolio annually is simply a good discipline that forces you to buy low and sell high.

For those of us who take a more hands-on approach to investing, I'd still say that moving out of expensive areas of the market and into cheaper ones isn’t market-timing by any stretch of the imagination. After all, if Mr. Market wakes up one morning and offers to buy an asset that you own for far more than you think it’s worth, you're usually better off taking advantage of his offer than waiting for a better one to come along. On the flip side, if investors are stampeding away from certain areas that still have strong long-term prospects, then you're buying assets for less than they’re worth. Nothing wrong with that--as long as you do it in moderation, rather than with abandon.

The big difference is whether you're looking at things from the top down or the bottom up. Generally speaking, market-timers advocate either being in the market or out of it, and that's just way too simplistic. "The market" is a complex beast made up of lots of different pieces--some of which might be attractively valued and some of which might be expensive at any given point in time. Instead of trying to predict where the whole morass is moving, it makes much more sense to focus on the individual pieces, and assess them individually.

This is why I get so riled up when people ask me, "So is now a good time to be in stocks?" Well, heck, I don't know. Do you mean big companies or small companies? Cheap stocks or "strong" stocks? What about REITs and bonds--or those long-suffering international stocks, for that matter?

At the end of the day, investing is about not keeping all of your eggs in one basket. It's about buying new eggs when they're on sale, throwing out the rotten eggs once in a while--and occasionally selling eggs when the market offers you Faberge prices for Grade A jumbos. Why bother with market-timing when the basic principles of investing are really that simple?