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May 30, 2015

Buy-and-Hold Still Works

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.
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.
About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here)  
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle
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