Making Buy and Hold Work
Thursday, May 28, 2015

We are currently offering an “early bird” discount for our Investor Conference. If you are considering joining us in Las Vegas this November—and I hope that you are—you can LOCK IN SAVINGS by registering before midnight on Sunday, May 31.

Now that we are nearing summertime, some of the podcasts I regularly listen to are airing rebroadcasts. (For those of you who are curious, my podcast list includes Freakonomics, Planet Money, Marketplace, the TED Radio Hour and Sound Opinions. I am also a regular guest on Chuck Jaffe’s MoneyLife Radio Show, and my weekly buy and sell analysis is available on the AAII blog.) In preparation for taking some time off (I’ll be back in the office next week), I took a look at my past Investor Update commentaries to see if there was an old one worthy of a “rebroadcast.” In the process, I came across this one from August 5, 2010, about portfolio diversification that I think remains very valid today (after a few minor updates were made.)

A few investors have opined to me recently that a diversified buy-and-hold portfolio strategy no longer works. Given the performance of the U.S. stock market over the last decade, I understand their frustrations.

I would counter, however, that they are misconstruing how a diversified buy-and-hold portfolio strategy should be managed. Specifically, buy-and-hold does not mean "buy-and-forget." Rather, it means investing with a long-term horizon, while regularly monitoring your portfolio and making adjustments as necessary to maintain proper allocation. I like to refer to this as “proactive” buy-and-hold investing.

The goal of buy-and-hold investing is to find a mix of attractive investments and purchase them with the intention of holding onto them for an extended period of time. Ideally, each investment should add to the portfolio's diversification, thereby lowering the level of risk for a given level of anticipated return.

Changes should only be made when necessary. For example, you should sell a stock if a development in the competitive environment causes you to question the company's future prospects. Proceeds from a bond will need to be reinvested at maturity. You should also exit a mutual fund if its performance is lagging that of its peers.

Portfolio allocation is also a factor. If your goal is to maintain a 60% allocation to stocks and, due to market movements, stocks now account for 70% of your portfolio, changes may be required. Investors who pay attention to their allocations tend to find opportunities to sell one asset class high and buy another asset class low. (Obviously, you should allow for some fluctuation in your allocation percentages, especially since transaction costs and taxes can offset the benefits of minor rebalancing.)

Finally, periodic monitoring of the portfolio is required. The frequency depends on the holdings and your tendency to trade. Checking an index fund's price on a daily basis is a bit like watching paint dry: Nothing much will happen that would cause you to act. (A daily change between 1% and 2% is within the normal long-term range of volatility for the major stock indexes and is not a reason to act, despite what the headlines on Yahoo Finance and other websites may otherwise imply.) An individual security should be watched for significant news such as an earnings release or a merger announcement, but you need to balance this with how often you would be tempted to trade based on new information. The idea is to check often enough so that you are aware of what is happening with your investments, but not so often that you are constantly tempted to tinker with your portfolio.

Will following these steps prevent you from incurring the pain of a market correction or, worse, a bear market? No. But, paying attention to asset allocations will help lessen the blow. More importantly, a proactive buy-and-hold strategy will keep you from trying to guess where the market will trade at tomorrow or next week, which often leads to underperformance.

Also, keep in mind that buy-and-hold investing and active trading are not mutually exclusive. I've met many investors who use a diversified buy-and-hold strategy for the majority of their portfolio holdings, but allocate a small portion for active trading. This can provide you with the opportunity to seek higher returns, while protecting the majority of your portfolio from potential mistakes and incorrect judgments about the market’s direction. It is not a strategy for everybody (both the risks and expenses are higher), but it does provide an alternative for someone who really wants to trade more actively.

More on

The Week Ahead

Six S&P 500 constituents will report quarterly earnings during the week. PVH Corp. (PVH) will report quarterly earnings on Monday; Dollar General (DG) and Medtronic (MDT) on Tuesday; Brown-Forman Corporation (BF.B) on Wednesday; J.M. Smucker Co. (SJM) and Joy Global Inc. (JOY) on Thursday.

This week’s first economic reports will be April personal income and outlays, the May PMI manufacturing index and April construction spending. All three will be released on Monday. May motor vehicle sales and April factory orders will be released on Tuesday. Wednesday will feature the May ADP employment report, April’s international trade, May ISM non-manufacturing index figures and the Federal Reserve beige book. On Thursday, investors can look for first-quarter 2015 productivity and costs information. Friday features May’s employment situation report.

Five Federal Reserve officials will make public appearances. Boston president Eric Rosengren will speak on Monday. Chicago president Charles Evans and St. Louis president James Bullard will speak on Wednesday. Federal Reserve Governor Daniel Tarullo will speak on Thursday and New York president William Dudley will speak on Friday.

What’s Trending on AAII
  1. 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses

  2. How Much Small Cap Should Be in Your Portfolio?

  3. EBT, EBIT, EBITDA: Will the Real Earnings Figure Please Stand Up?

AAII Sentiment Survey

In this week’s AAII Sentiment Survey, neutral sentiment continued to remain above 45%, in a streak that has now reached its eighth consecutive week. Optimism increased, but remains well below its historical average.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 1.8 percentage points to 27.0%. The drop keeps optimism below its historical average of 39% for the 12th week in a row.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 1.9 percentage points to 47.9%. Although neutral sentiment declined, it remains above 45% for the eighth consecutive week and above its historical average of 31.0% for the 21st consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 0.1 percentage points, to 25.1%. This is the 18th week this year where pessimism has been below its historical average of 30%.

Bullish sentiment remains at an unusually low level, while neutral sentiment continues to stay at an unusually high level. Historically, such readings—both unusually high low bullish sentiment and unusually high neutral sentiment—have been correlated with better-than-average market performance over the following six- and 12-month periods. I wrote about this in Analyzing the AAII Sentiment Survey Without Hindsight in the June 2014 AAII Journal and updated the data in AAII’s May 21 Investor Update, Unusually High Neutral Sentiment Often Followed by Good Returns. There is no guarantee history will repeat itself in the future, however.

Causing some AAII members to be cautious or pessimistic are prevailing valuations, recent price volatility, geopolitical events, the pace of economic growth, the impact of the stronger dollar on earnings growth and worries that a notable decline in stock prices could occur. Keeping other AAII members encouraged are the ongoing bull market, sustained economic expansion, earnings growth and still-accommodative monetary policy.

This week’s Sentiment Survey special question asked AAII members what sectors or industries they are currently favoring. About 35% of respondents favored the healthcare sector, 20% were optimistic regarding technology, approximately 17% were bullish regarding energy, 10% preferred financials, 6.8% liked consumer staples, 5% favored industrials, 3% were for consumer cyclical and 2.6% were bullish toward basic materials. Within each of the sectors, there was favoritism shown toward biotechnology, pharmaceuticals, oil and gas, real estate, and banks. There were some mentions of emerging markets and European stocks as well.

Here is a sampling of the responses:

  • “Biotechnology, pharmaceuticals and oil and gas.”
  • “I like consumer discretionary, because those in upper income brackets will spend consistently. I also like manufacturing, as long as the companies are sound.”
  • “Big pharma is my favorite sector right now. The introduction of biosimilars is heating up the competition. Let the winners run.”
  • “Oil has been beaten down quite a bit in the last year. Some snap back is likely, in my opinion.”
  • “Health-related industries. Demand for services and/or medications when needed does not go down with the fluctuations in the overall economy.”

This week’s Sentiment Survey results:

Bullish: 27%, up 1.8 points
Neutral: 47.9%, down 1.9 points
Bearish: 25.1%, up 0.1 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!