The Buy and Hold Forever Fallacy

A long time commenter on this blog, Canadian Money, as been bugging me for a bit to do this post.  You can see CM’s original comment here.

Buy and hold is a old concept, but most recently made more mainstream following Derek Foster’s book, Stop Working (see my review) where he called it ‘buy and never selling’.  The idea is somewhat simple.  If you don’t sell stocks you can’t be taxed on your capital gains if you hold it in a taxable account (or you don’t lock in your losses until you sell).  The entire approach sort of admits you can’t time the market so why try.  Instead the approach relies on dollar cost averaging and the fact eventually the market will keep going up and replace any losses you had during down times.

Overall it sounds good, so like most fallacies it falls apart under unusual events.  You see most items like this are created when people start to believe there are some overall trends to the market after a period of time and therefore you can predict it.   So you get statements like over the long term stocks out preform bonds.  Yes that is generally true in history, but the prediction is never quiet right.  It’s sort of like weather forecasting, it’s an educated guess of what’s going to happen with lots of data backing the decision, but in the end it is still just a guess.

The problem with the belief of buy and hold is the timing and length of recovery.  For example after 1929 it took until about 1955 for the market to recover (I’m using the DJIA as a backdrop for this discussion) or 26 year.  Then from 1965 until about 1982 the market just stayed in a rut and didn’t hit any new highs for that period of 17 years (see CM’s post for the chart).  In both cases waiting for the stock market to recovery when you are in your retirement may not have been an option, you may have required some of that money that is tied into the stock market and therefore never saw the recovery.

With buying into buy and hold people end up having too much faith in the market.  In 2008/2009 many baby boomers are praying for a recovery to let them retire.  The fact the recovery may take decades I don’t think has sunken in yet.  The recovery may very well be a long time in the making, so yes buy and hold will work if you can wait long enough.  The issue with retirement savings is you can’t always wait that long if you are living on that money (or expecting to be living on it soon).

Even Derek Foster saw the light and admitted in his second book that he sold certain stocks and buy others.  Why?  Because the situation you buy a stock in can change and if it changes enough it is completely alright to sell it.  The how and why of that will depend on you and your situation.

So in the end, buy and hold does work if you have decades in front of you, like in your twenties.  Yet in your fourties or fifties, the shine on the idea has worn off because the associated risks to your retirement lifestyle.  The end of the lesson from this bear market is don’t take more risks than you need because you are greedy.  You can get burned.

So what are your thoughts on buy and hold? Do you use it, if so, why?

5 thoughts on “The Buy and Hold Forever Fallacy”

  1. Buy and hold to save taxes is certainly very reasonable. When you sell, you lose about 25% of the gain in taxes. This wouldn’t be a problem if there weren’t other ways to get at the money, but you can borrow against the gain and invest in something else for example.

    Buy and hold in an RRSP environment or TSFA is irrelevant.

    Sometimes you have to sell because there are better ways to use your money. It’s just a financial decision. Sum up the costs and benefits of each alternative and take the best one.

  2. If you’re holding forever, the only return you get is from dividends. So then you have to look at the yield you’re getting, how sure you are that it will continue, and what other investments you could buy that might have a higher yield. Not every stock will have a yield higher than a simple inflation-indexed bond.

  3. I don’t think it’s very fair to compare the 1929 peak value and say that it takes until 1955 to recover from that peak.

    What happens if someone started in 1910, dollar costs the whole way through, reinvests dividends, and starts trying to live off of the proceeds after 40 years (1950 end point). What happens then during the crash?

    This is why I really like the retirement calculator over at Fire Calc. It runs through every rolling historical period for your strategy and tells you how you would have done and your success rate. I think this is much more appropriate for peopel planning to run through a few scenarios and see how things would have done in the past.

  4. GH & SP,

    Good points. Thanks for sharing.

    Trac,

    I don’t mind Fire Calc either, but I don’t consider it ‘the’ calculator. It does provide an interesting ability to run your situation through past events to see how you would do. Yet people sometimes get obsessed with getting high scores on it.

    Tim

  5. Buy and hold is laughable, I know the turtle beats the hare, but there have been 10 year periods where most people just broke even and was at a standstill

    I say do the both and hold and in addition to that have other investment strategies

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