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Posted 8/23/2004
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'Buy and hold' can mean 'hold and lose'
It was one of the great mantras of the 1990s. If you buy a stock and hold it forever, you'll be rewarded. This strategy carries far more risk than many investors might expect.
By Bill Fleckenstein
The 1990s stock market mania was fertile ground for a number of powerful and popular myths. One of these myths has survived the trip to 2004 rather well: "I don't really have to worry about what stocks do in the short run because I'm in it for the long haul." A second and equally powerful myth was the belief that stocks just had to go up, because where else were people going to put their money?
Do you remember that? People thought stocks couldn't go down because they were the only game in town. Whenever you hear folks making that statement, you know you're deep into the process. That rationalization is always destined for failure because people can put their money anywhere, and it's usually a rationalization favored by novice investors to justify doing something on a larger scale than they should.
Similarly, "I invest for the long term" is often a rationalization for sticking with a losing idea. When I personally invest "for the long term," I'm thinking three years, maybe five years. You can have a reasonable opinion about what might happen over the next three to five years and maybe make some decent guesstimates. But, in my opinion, thinking that you know what's going to happen in 10 or 20 years and buying stocks on that basis is really just a rationalization.
Toys R Us: A great teaching tool for the long-term investor
This was brought home to me by a couple recent stories in the papers. First was an Aug. 12 Wall Street Journal article, Toys 'Were' Us?", which discussed the demise of Toys R Us from a toy retailers' standpoint. When I first got into the investment business 25 years ago, Toys R Us was a juggernaut, and, of course, it was a juggernaut for much of this time. But a quote from the article illustrated a very critical point that "long-term investors" must keep in mind. Burt Flickinger, managing director at the Strategic Resource Group in New York, said: "It's a sad day in retailing when Toys R Us declares victory, runs all the competition off the cliff, and then Wal-Mart kills off the only surviving toy retailer."
The moral of that story: Folks need to think about businesses they own from a competitive standpoint. In other words, what is the barrier to entry in this business? Very, very few businesses have barriers to entry. Not having a barrier to entry means that if you have a decent profit margin, you will be subjected to intense competition.
One of the dirty little details that's never discussed on Bubblevision, or by many of the perma-bulls, is the fact that a lot of businesses don't have barriers to entry, and paying historically high valuations for them is basically a recipe for disaster.
Sometimes, you just need the money
Another point I tried to make in the mania -- when people would say, well, I am in this for the long term -- was to point out that the problem with investing for the long term (meaning the next 10 or 20 years) is that from time to time, life issues its margin calls, and oftentimes does so at an inconvenient moment. Often when you lose your job or experience a similar loss, that's the same time that house prices or stock prices decline.
This nugget was demonstrated by "Asset mix took toll on United's pension fund, an Aug. 13 New York Times story on United Airlines and its pension fund. Mary Williams Walshs story chronicled some of United's less-than-conservative investments, noting how common that strategy is within corporate America's pension funds these days.
Walsh went on to offer the following moral: "While United's investment results were not far out of step with other pension funds, the losses had a far more devastating effect on the fund because they coincided with United's own business troubles." (The emphasis is mine.) In other words, life was issuing its margin call for United at a most inappropriate time. (In fact, I would argue that, if you were running a particularly dangerous business, as the airline business is, you should have an even more conservative investment mix in your pension plan than a less conservative one, but that is another issue.)
Bailouts are no boon to taxpayers
Of course, corporate America doesn't really worry about this because they know they've got the Pension Benefit Guaranty Corp. as a backstop. The PBGC is supposed to step in when pension plans fail, but it encourages a company to swing for the fences because, if the play works, it lowers the company's pension costs. If it doesnt work, taxpayers pick up the tab. It's a heads-they-win-tails-we-lose problem.
This is exacerbated because of the insane way that pension gains can be used to bolster corporate profits. The article very succinctly explained it this way: "The accounting rules for pension funds help, by allowing companies to project the long-term gains they expect from their pension investments, then factor that projection into their bottom lines -- even in years when the projections are dead wrong."
So there you go. Place money in risky assets, assume that they're going to grow at some rate of return, and then as that rate of return is higher than the assumed rate you need to match off your liabilities, ergo, you have a profit. This whole pension mess is just another lurking time bomb that folks need to be aware of.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, Bill Fleckenstein held no positions in the equities mentioned in this column. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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