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More evidence that buy-and-hold wins
Impatience is decidedly not a virtue in the investment world. A comprehensive new study shows that stocks are best bought and held for many years.
By Harry Domash
One of the evergreen debates in our Start Investing Community is about the wisdom of buy-and-hold investing vs. timing the market. So I was interested the other day to find another study that concludes that buy-and-holders win.
Now, before the market timers in our community start to get their hackles up, I want to point out that the study doesnt compare the kind of systematic timing they talk about to buy-and-hold investing. What it does compare is an investor who holds a stock fund for the very long term -- in this case, 17 years -- to the average fund investor, who retains a fund for slightly less than three years. So the study doesnt include the results of those who use some kind of technical analysis to time the market. Yet it is very relevant to the average investor, especially those who call themselves buy-and-holders.
This is what I see happening to most investors -- including myself -- who say they buy and hold. After a long period of underperformance by the stocks or funds they hold, they bail out and move to the current top performers. A long time varies by individual -- one year, 18 months, two years. Its difficult to be patient when youre losing money.
Bonds beat stocks?
The study, done by Dalbar, a financial research company in Boston, looks at how the average investor in stocks, bonds and money market funds fared during one of the greatest bull markets in history, the period from Jan. 1, 1984, to Dec. 31, 2000. None of the investors did great. But bond investors fared better than stock investors, even though stocks outperformed bonds by nearly 5 percentage points. The reason is that stock investors didnt hold onto their investments long enough to capture those returns.
Here are the results:
| Stocks and bonds over the long run | | Avg. Annual Return | Cumulative Return | | S&P 500 | 16.29% | 1,201.39% | | Avg. stock fund investor | 5.29% | 141.46% | | Long-term govt. bonds | 11.83% | 569.41% | | Avg. bond fund investor | 6.08% | 172.69% | | Treasury bills | 5.82% | 161.46% | | Avg. money market investor | 2.30% | 47.01% | | Inflation | 3.23% | 71.70% |
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Efforts to time the market are unsuccessful for the majority, the study concludes. I agree with those results but am reluctant to conclude that the average investor is trying to time the market. Instead, I think hes just bumbling along and making the wrong decisions.
The study looks at cash flows into and out of mutual funds to determine the length of time investors remain in funds. Retention is computed by dividing assets by monthly redemptions and then calculating real returns for investors in the various funds. The returns are compared to a benchmark.
The annual returns on the benchmarks are pretty impressive. But the cumulative returns over the 17-year period are stunning. What they say is that investors should put their money into a fund like the Vanguard 500 Index (VFINX) or the S&P 500 spider (SPY, news, msgs) that trades on the Amex or a similar large-cap growth fund and let it sit.
Three-year attention span
Actually, I was not so much surprised that the average investor doesnt hold a fund for 17 years as I was that he holds it as long as he does. At the end of 2000, stock-fund retention averaged 2.6 years. Insurance companies see a big drop-off in cash-value insurance policies after a similar time span. It makes me wonder if our attention span as investors is just under three years. I have just one investment, Dodge & Cox Stock (DODGX) fund, that Ive owned more than 10 years. I wonder how many of you have funds that youve held for 10, 15, 20 years.
The problem is not so much bailing out when the market goes down as just bailing out. The study's authors observe that equity fund investors remain calm during market turmoil. The retention rate has remained constant since 1992, in spite of great volatility in the market and the big declines of 2000. This demonstrates that consumers have learned not to unload their equity funds in a rush of panicked selling when the market drops, the study says. Indeed, the study says, investors were far more patient in 2000 than in the 1987 market crash.
So the good news is that we panic less as investors. The bad news is that investors still tend to buy when market prices are high, according to the study. Thats clear from looking at fund flows in 1999 as the market was hitting new highs and net cash flow to funds was positive, meaning that more investors were putting money in than taking money out.
The results of the study show that stocks are still the place to be. But most of us would be better off in Treasury bills than dealing stock funds like a deck of cards. Buy and hold means setting up a portfolio and letting it sit. Dalbar looked at average stock returns for each of the eight ten year periods. Not one was negative.
| How buy-and-hold fared | | 10-year period | Return | 10-year period | Return | | 1984-93 | 6.33% | 1988-97 | 8.94% | | 1985-94 | 5.20% | 1989-98 | 10.33% | | 1986-95 | 6.97 | 1990-99 | 10.79% | | 1987-96 | 7.35 | 1991-2000 | 8.45% |
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Instead of calling it buy and hold vs. market timing, I think we should compare patience over the long term to regular fiddling with your portfolio, selling off funds every two or three years to replace them with something that looks more glamorous.
At the time of publication, Mary Rowland owned or controlled shares in the following equities: Dodge & Cox Stock and S&P 500 spider.
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