The Misleading Campaign to Discredit Buy and Hold

Today’s Wall Street Journal continues the seemingly coordinated effort to invalidate buy-and-hold investment strategies with yet another article discussing “professional” advisers ditching buy-and-hold for market timing approaches. It seems not a day passes without some hack commenting that today’s markets have turned everyone into traders or that buy-and-hold no longer works. I even had a friend who casually follows the markets tell me that buy-and-hold was dead. And with Wall Street reporting strong Q1 earnings from their trading operations, is it any wonder why the media is pushing this narrative?

Buy-and-hold is far from dead but perhaps it has been misunderstood. As with many other investment topics, it is instructive to look to Warren Buffett’s example.

Perhaps no other investor personifies buy-and-hold more than Buffett, who has stated that his preferred holding period is forever. But as with all things Buffett, this folksy tidbit is not his final word on this topic. When it comes to the Oracle of Omaha, we need to observe Buffett’s actions as well as his words and for that, we go back to Buffett’s early days running his hedge fund.

In letters to his partners, Buffett laid out three investment categories (later expanded to four): generals, workouts and controls. The generals were the buy-and-hold portion of his portfolio and usually comprised the largest portion of his holdings. These were value stocks he bought but was unable to predict when he would realize the expected gains. In fact, he warned that these stocks could suffer long periods of underperformance. The controls were similarly undervalued companies but where Buffett could take an activist (or controlling) role which could provide an impetus for realizing the value in these positions. Both of these categories could be labelled as buy-and-hold strategies.

The workouts, by contrast, were short-term investments with defined timelines and catalysts for validating the investment thesis. By their nature, these were not buy-and-hold investments yet they were an integral part of his early investment strategy. It is important to remember that Buffett was running a hedge fund and unlike today’s charlatans, refused to be paid unless he made money for his partners. This provision also ensured he was very motivated to deliver positive annual returns. The workouts segment was instrumental in providing near-term, relatively dependable returns to balance out the buy-and-hold portion of the fund’s holdings.

So what’s this talk of the death of buy-and-hold all about? I view it as yet another disingenious attempt by the financial services industry to compensate for their own deficits. Two glaring deficiencies spring to mind.

First, the industry peddled the concept of “stocks for the long run”, the notion that investment returns were guaranteed if investors simply held over a long enough period. This implied that in the long run, the price you paid for stocks was relatively unimportant since they eventually would move higher. I can not imagine Warren Buffett agreeing with the implication that the price paid to own a stock is not critical. The whole concept of value investing revolves on the price paid for the asset.

Second, the financial services industry failed to properly construct many portfolios to guard against the unpredictable nature of markets. How many stories have we read of people near retirement prolonging their careers due to massive drops in their nest eggs? While financial advisors can not be expected to engage in the workout opportunities that Buffett used (arbitrage, etc.), even a simple age-based stocks/bonds portfolio allocation would have mitigated losses. This is the basic premise that a person’s fixed-income allocation should match their age and is designed to reduce stock market exposure as you get older. So if a person is 60 years old, his portfolio should be 60% bonds / 40% stocks. Of course, there are many ways to approach this problem but even the most basic of strategies would have helped greatly.

So don’t believe the hype. In fact, buy-and-hold is one of the most important tools for the retail investor to compete against institutional investors. Our long-term focus allows us to take advantage of market dislocations created by the structural short-term bias of the major market players. The key is to properly apply the strategy.

I combine buy-and-hold investments with simple option strategies to gain a balance between unpredictable long-term holdings and near-term realizations. Merger arbitrage, going-private transactions, warrant hedging and other strategies can help achieve this goal as well.

Remember, if Rule Number 1 is don’t lose money and Rule Number 2 is don’t forget Rule Number 1, then Rule Number 3 is that there are no other rules — only guidelines which need proper judgment to be applied correctly.

As always, YMMV.

4 Responses to “The Misleading Campaign to Discredit Buy and Hold”

  1. Neil Says:

    Hi Davy,

    While I think you’re broadly right, it’s worth bearing in mind that Buffett’s personal portfolio was entirely in short term government paper before October last year. In fact Graham and Buffett advocate market “PRICING” instead of timing. When the market rises sufficiently they advocate holding more and more cash. Not exactly buy and hold.

    In fact, with much consideration, I think that Graham really advocates buying securities and selling when they reach near fair value (or simply after they rise substantially) at the same time as a cash allocation based on market rises. Buffett’s buy and hold forever is only practiced with a very small part of his portfolio and with the very highest of quality US stocks.

  2. Davy Bui Says:

    Definitely with you on this one. I definitely don’t recommend a holding period of forever and if you look at Buffett’s actual track record, it’s definitely another case of do as I say, not as I do.

    Cash holdings should automatically rise as markets head higher if one sells near intrinsic value. When the market is at its peak, few stocks will qualify for long-term investment.

    Graham definitely wasn’t beyond market timing. After all, he did try to warn Buffett against striking it out on his own because the market was going to head back below 1,000. Graham was wrong.

    The amazing thing about Klarman is that he’s generated much of his returns despite a monster cash allocation.

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