Buy and Hold is Bullshit

With stocks having recently hit levels not seen in more than a decade, it’s a good time to address the “investment strategy” of “buy and hold.” Promoted by just about every well-known financial adviser and financial guru, it’s time that buy and hold be called what it is: a sham.

Perhaps the best evidence of that comes in the form of Warren Buffett – the classic “buy and hold” investor. He was recently forced to tell Berkshire Hathaway shareholders that he “did some dumb things in investments.”

He sure did. Not only did he buy into certain companies at the wrong time, he sat on his paper gains and rode many of them back to where they started – or worse. Is that the work of an Oracle?

I’m not a billionaire but as far as pure percentage returns go, I beat Warren Buffett handily last year and I continue to beat him handily this year with an intraday long-short strategy that involves stock and options. Many others can claim the same.

Sure, despite Berkshire Hathaway’s horrible year, it’s not like Buffett is going bankrupt. His sweetheart deal with Goldman Sachs provides $500 million in income every year. So even if GS stays in the shitter, Buffett isn’t exactly losing on his investment in the investment bank.

But the reality is that Warren Buffett’s long-term buy-and-hold strategy doesn’t work for the average investor. In fact, it’s probably the biggest scam perpetrated on the general investing public.

Let’s look at the past decade. Here’s a scenario many people know quite well because it’s their personal story. You might know it.

You invested in a broad range of equities in the late 1990s, likely through a “diversified” portfolio of mutual funds. Your 401k grew nicely as the .com bubble inflated. Early retirement? It crossed your mind.

Then it all came crumbling down. Your investment adviser told you to stay calm. The market would come back and that it was no time to sell. In fact, at some point he probably told you it was the perfect time to buy because you were getting the opportunity to load up on more stock for fewer dollars. The bottom was right around the corner.

Sure enough, the market rebounded and you went into late 2007 feeling good. Of course, you never really cared about the forces that were driving the market higher and whether they were healthy or sustainable.

In October 2007, the market peaked but you held through it. Well into 2008. Your investment adviser never told you that market conditions had changed. Chances are he wouldn’t know how to read a chart if he read Technical Analysis for Dummies (which, by the way, probably isn’t such a bad book).

As the market started to look bad in mid-2008, your investment adviser told you to hold tight. Just like before, he reassured you that the market would rebound soon. In the final quarter of the year when the market was tanking, he told you it was no time to sell because you’d lock in your losses.

As I noted, bear market rallies are not unheard of and in December we saw a decent one that conforms to past bear market rallies. Your financial adviser mistook December and January as a sign that a bottom might be in. Unfortunately, he was wrong and now you’re sitting on even greater losses.

Your investment adviser is still telling you not to lock in your losses and may even be encouraging you to start buying again. It can’t go much lower than this. Fair market value this. Price to earnings ratio that. The recent rally could be a bottom!

Does this sound like a good wealth creation strategy? Of course not. The dwindling value of your 401k, IRA or investment account tells you that.

The problem with buy and hold is that its adherents make the flawed assumption that the stock market, over the course of years and decades, tends to go up. And, when you look at price alone, it appears to have been doing that for quite a while – at least since the bull cycle that started in 1982.

So what’s wrong? You have to look at the big picture.

When you invest in the stock market, the goal is not to watch the paper value of your investments go up. When you invest in the stock market, the goal is to create wealth.

Wealth is not paper gains. Wealth isn’t even cash. Paper gains can rapidly become paper losses. And cash can lose its value too.

So how do you create wealth in the stock market? By maximizing profit and taking it so that you can stash your gains in assets that (hopefully) safeguard your wealth or provide for a life.

As a technician, I say “The charts don’t lie.” A price chart tells you what the market is thinking right now. Applying even the most basic technical analysis, the average investor can avoid more than 90% of the investment mistakes he’s apt to make because he can prevent himself from going against the prevailing trend. By understanding more complex chart patterns and gaining an understanding of technical indicators and divergences, an investor can gain further insights, such as likely trend reversals.

So what of this notion that the stock market tends to go up over the long term? Where does that come from? If you’re looking at a price chart of a major index like the Dow over a long period, the price chart can fool you.

Unfortunately, looking at a long-term picture of a major index without adjustments for inflation is misleading. If you look at an inflation-adjusted chart of the Dow, for instance, a much different picture emerges than if you simply look at a chart without inflation factored in.

Note that the inflation-adjusted chart linked to in the paragraph above includes some non-US-government inflation estimates. Long story short: the US government lies about inflation. The chances of the US government ever measuring and publishing accurate inflation data are about as good as Tim Geithner learning how to use TurboTax properly.

Since I (and many others) have concerns over the fate of the US dollar, another interesting way to look at the market is to price major indexes in gold. Take a look at the Dow since 1998. While price in dollars was peaking, price in gold was telling a very interesting story. Gold prices are a tricky subject that’s beyond the scope of this post but I will say this: the decline of major indexes over the past decade when priced in gold was saying something.

So back to “buy and hold.”

If you listen to the pundits and the analysts (few of whom, incidentally, predicted this meltdown), you’ll continue hear nonsense about “Well over the next 10 years…” When it comes to the fact that Warren Buffett’s buy and hold strategy has left him with losses on a number of investments that he previously had tens of billions of dollars in paper gains on, people say “Well his timeframe is 10-20 years.” And financial gurus like Suze Orman continue to spew bullshit about “If you need money from your investments within the next 5-10 years, take it out of the stock market” (implying, of course, that the stock market is a safe place to park wealth if your horizon is more than 5-10 years).

Folks, these people were saying this stuff 5 years ago, 10 years ago, 20 years ago.

Markets change. Their advice doesn’t. What does that tell you?

All told, the popular myth of buy and hold that is sold to every Average Joe has cost millions of people trillions of dollars of wealth potential (it was never real wealth because you’re nobody until you’re liquid).

I see this potential on a regular basis. In a good week, I’ve personally pulled 15 points in gains out of stocks trading in a range of ~3 points. That’s a lot of money. Now I’m not suggesting that the average investor sit in front of a computer every day trading 5″ charts to maximize his wealth creating potential. That’s not going to happen.

But average investors do need to understand that the stock market isn’t a perpetual hockey stick. If wealth creation was as simple as putting money into a bunch of mutual funds and watching their holdings increase in value, everyone would be wealthy.

The same flawed reasoning and advice convinced millions of people to look at home ownership as an investment. Home prices always go up over long periods of time, everyone was told. That worked out real well too.

The bottom line is that buy and hold doesn’t work. There’s a time and a place to buy and that means there’s a time and a place to sell. You don’t buy when you don’t have a good reason to and you don’t hold when you’re given a good reason to sell.

For those who still trust Warren Buffett’s advice over mine and countless others who made a great deal of money in 2008, I say this: enjoy what’s left of your 401k.