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Is Buy-And-Hold Dead?

Is Buy-And-Hold Dead?
January/February 2010


Larry SwedroeLarry Swedroe, Principal and Director of Research, BAM Advisor Services

JOI: Is buy-and-hold investing dead?

Swedroe: I almost have to laugh whenever I get a question like that. It’s similar to the question, “Is diversification dead?” Whenever we get some kind of crisis, all those who believe in active management come out of the woodwork with this nonsense. All that shows is that they don’t know the basics of investing. Any student of history and investing would know that during a financial crisis that is systemic around the globe, the correlation of all risky assets always go towards 1. It has happened many times before.

But still, they come out of the woodwork …

There was actually an article in [the Oct. 11, 2009 issue of] Investment News, titled, “The days of buy-and-hold have gone and went.” So let’s deal with that issue.

It’s a very simple mathematical fact?which William Sharpe demonstrated in his nice little paper called “The Arithmetic of Active Management,”?that active management must lose in any environment or any asset class. Anyone who says otherwise should be required to wear a shirt that says, “I can’t add,” in big, bold letters. There are only two types of investors: active or passive. So, let’s say you are a passive investor and you just want to own Vanguard’s Total Stock Market Fund [NYSE Arca: VTI]. If the market goes up 10 percent, before expenses, you must get 10 percent, as all passive investors do. And that means, in aggregate, the active investors have to get 10 percent, before costs. The same math applies in down markets.

Since active investors have higher expenses, active investors must lose after costs. As Sharpe points out in his article, anyone who produces a study that finds anything different is simply measuring the wrong things.

JOI: Should investors be concerned about inflation during the near term? If so, how can they protect themselves against it?

Swedroe: Let me say it this way: William Sherden was an economist called to testify in front of Congress on near-term inflation. He got the brilliant idea to say, “You know what? I ought to check the track records of these other geniuses like me who have previously been called to testify on the outlook for inflation and see if they got it right.” And guess what he found? He found these geniuses had no better forecasting record than what is called the naive forecast. In economic terms, that means, if inflation is currently 3 percent, you project 3 percent. In other words, they were no better than monkeys throwing darts.

He found that even the forecasts from the people who impact the outcome—the Congressional Budget Office, the Council of Economic Advisers and the Federal Reserve—and therefore have some degree of controlling it, were not more accurate.

However, a recently published paper found that taking a consensus forecast—while it’s not a good forecast—is better than most. The Philly Fed Survey forecasts inflation of roughly 2.5 percent. And, by the way, there is a swap market for inflation; it was also at about 2.5 percent not too long ago.

JOI: Have you adjusted your investment philosophy during the last two years?

Swedroe: [We have adjusted] nothing. For 15 years we had exactly the same investment philosophy because our advice is based upon what I would call the science of investing and evidence-based investing. The evidence today is—if anything—stronger that passive management is the strategy most likely to allow you to achieve your financial goals. The only thing that we’ve done in the last 15 years is added recommendations that investors consider adding a small allocation to commodities.

With the advent of TIPS, we began to strongly recommend that people use TIPS as the dominant portion of their fixed-income portfolio in tax-advantaged accounts. Another minor thing is that we have adjusted our international allocation over time. Fifteen years ago, I think we were recommending 30 percent U.S. Now we are recommending 40 percent. If we were pure market-cap weighters, we would be at 60 percent international. But we think there are logical arguments for having some home-country bias.

JOI: What’s the biggest danger/opportunity that you see ahead for investors during the next five years?

Swedroe: I think the biggest danger for investors is what they see when they look in the mirror.

The second [biggest danger] is ignorance, because they don’t know the science of investing. They are tempted by the wolves of Wall Street and their advice. The third thing I would say is, if they can’t resist watching CNBC, they should do it with the mute button on. Because what they are likely to hear could only cause damage by stirring the emotions of fear and envy in bear markets, and greed and envy in bull markets. The best strategy is what Warren Buffett advises: “Invest in index funds and stay the course.”


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