Letting Go: The Death of Buy & Hold

The unraveling of the financial markets and emergence of new technology has poked holes in the time-tested investment strategy of "buy and hold."
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NEW YORK (TheStreet) -- The past two years of panic and uncertainty may have finally sounded the death knell for "buy and hold."

The investment strategy was pushed forward in the 1970s by Vanguard founder Jack Bogle, who believed time was on his side. A lot of other fund managers shared his view, and helped enforce its grip on conventional wisdom. It's easy to see why.

"Buy and hold" is simple: Pick a company with good "fundamentals" and a bright outlook. Buy its stock. Wait for it to appreciate.

The catchy slogan doesn't directly address how to pick stocks -- or the exit ramp -- but investors have accepted it nonetheless. The simplistic view of the market's inflationary nature was proven out over a very long period of time. During the 20-year bull market that preceded the so-called aughts, there were a few downturns that helped to reinforce the belief that "buy and hold" would endure.

The Unraveling

During the 1980s and 1990s, the average annual return on the S&P 500 was 15%. At the start of 2000, the index was 14 times higher than it was at the start of 1980 -- despite four down years and several mini-crises that were thought to be significant at the time, but pale in comparison to the subprime bubble and its enormous ripple effects.

The decade of excess that followed wiped out much of those gains -- in confidence as well as outright returns. The '00s represented the worst period for stocks ever recorded, including the Great Depression.

Among the few winners were those who bought into rallies and quickly let go, or those who shorted the housing market and financial stocks, rather than placing long-term investments.

In fact, the average amount of time that an investor holds a stock has plunged from 10 years at its height in the 1940s, to six years in the mid-70s, when the term "buy and hold" was popularized, according to an analysis by Société Générale. In November 2009, the average duration dropped below one year for the first time on record, according to NYSE data. (As James Montier, a respected asset-allocation expert who authored the SocGen report put it, "Under this time horizon, the only thing that anyone cares about is: What is going to happen next quarter?")

Perhaps it's unsurprising that the market's mindset has shifted from long-term value investing to short-term profit making. The 24-7 news cycle has allowed a constant flow of information, while new technology has provided new means of distribution and ways to execute trades faster.

It's estimated that computerized trading accounts for roughly 70% of stock-market volume each day. In a coincidental parallel, roughly 70% of the "erroneous" trades that occurred during the "flash crash" in early May were related to exchange-traded funds, which track market movements rather than individual stocks. (Bogle recently called investing in ETFs

"insane" for long-term growth.)

All of these factors have changed the game for stock-market investors, often squeezing individuals into a frenzied corner. Roughly $243 billion poured out of equities in 2008 and 2009, according to the Investment Company Institute. Stock investments began to pick up at the start of this year, but quickly tapered off, with outflows over the past six weeks nearly wiping out the gains through April.

Meanwhile, volume has climbed tremendously. Tens of millions of shares pegged to the S&P 500 traded hands each day in the 1980s, hundreds of millions in the 1990s, and billions in the '00s. Volume topped 10 billion on three key trading days over the past couple of years: September 18, 2008, just after the collapse of Lehman Brothers,

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

; October 10, 2008, when perceived credit risk reached a record, as measured by the TED spread; and on the

"flash crash" of May 6.

"There's an awful lot of chaos and fear, which, in turn, leads to uncertainty, which, in turn, leads to volatility," says Jim Hansberger, managing director at the Hansberger Group of Morgan Stanley Smith Barney. "Volatility scares people -- and they're already scared."

Skeptics Emerge

While Hansberger is a supporter of the "buy and hold" method, J. Michael Martin, chief investment officer of the Columbia, Md.-based wealth-management firm Financial Advantage, sees it differently.

"'Buy and hold' worked as a strategy in the '80s and '90s when a rising tide lifted all boats, but it doesn't in the 2010s," says Martin. "I'm sure you've heard of 'buy the dips,' too, but that's morphing into 'sell the rallies.'"

Thus, the "buy and hold" formula has been thrown some unusual hardballs lately:

How do you decide what to buy? Even professional analysts have been questioning the best way to value stocks -- forward earnings vs. book value vs. cash flow vs. leverage -- since time-tested methods have

fallen terribly short.

Does it even matter? Seemingly inexplicable forces -- what Hansberger referred to as "animal spirits" -- have proven themselves far more powerful than valuation models on several occasions. The most recent one sent the

Dow Jones Industrial Average

careening 1,000 points, and

Procter & Gamble

(PG) - Get Report

shares plummeting, for just a moment in time.

Assuming you've selected a stock and are daring enough to brave the animal spirits, the most important question is one that "buy and hold" doesn't address at all: When to let go.

"You've gotta have stop-losses," says Jody Eisenman, CEO of the investment bank PHD Capital. "You've gotta have a point where you say, 'I was wrong, I'm out.' Nobody thought

Citigroup

(C) - Get Report

was going to lose 90% of its value. It's not a crime to lose money on a stock, but you can't ride it from 40 down to 3."

Eisenman founded PHD in 1995. It now owns a broker-dealer and a hedge fund, and is involved in a wide array of transactions, from M&A and capital-raising, to derivatives, REITs and exotic investment vehicles like

SPACs. Still, Eisenman, who cut his teeth at Lehman Brothers in the 1980s, sounds melancholy about the changing ways of Wall Street, even if he has adapted well.

He notes that while electronic trading dominates, computers are unable to realize disconnects that are obvious to humans or protect investors' interest the same way. A friend of Eisenman's recently decided not to pursue a job working the floor of

NYSE-Euronext

(NYX)

because he felt there wasn't any room for growth or development.

"The New York Stock Exchange today is almost an anachronism," he reflects.

The Gospel of Chuck

Today's market is eerily reminiscent of a phrase in John Maynard Keynes' 1936 treatise

The General Theory of Employment, Interest and Money

: "Investment based on genuine long-term expectation is so difficult today as to be scarcely practicable."

Seventy-five years later, during another nascent recovery, it seems to apply more than it did in the famed economist's post-Depression era.

Still, despite the dwindling ranks of long-term stock investors, many fund managers continue to preach the gospel of "buy and hold." When asked whether there are still stocks to own for five or 10 years, Smith Barney's Hansberger replies: "Absolutely." Bogle

still stands by his mantra as well.

Don Hodges, who founded his Dallas-based money-management firm Hodges Capital Management in 1989, says "buy and hold" isn't dead; the execution simply requires more elbow grease. He believes the current environment is full of opportunities, though more challenging to navigate than ever before.

"I just finished my 50th year in the business," says Hodges. "One of the conclusions I've come to is if you're in the market to make money -- as opposed to having some excitement -- the best way to make money is to find companies that have a product or service that has the capability of becoming something big and buying it and holding onto it."

However, the strain of the past few years is evident, even while Hodges describes himself as a strong believer in capitalism, American entrepreneurship and the notion that hard work will pay off. He says he's "bewildered" by wild swings in the market and at a loss when clients demand explanations to help calm their nerves.

"I'm just not sure what to tell individuals, frankly," says Hodges. "You probably detect a little bit of frustration in my voice."

David Hefty is a fund manager on the other side of the dial. He not only disregards the "buy and hold" philosophy as outdated and unreliable, but is skeptical of its origins. Hefty believes big mutual fund firms like Vanguard, Fidelity and

Charles Schwab

(SHW) - Get Report

spread the catchy phrase as a way to corner the market by implying guaranteed returns.

"And here is the great irony of all this," says Hefty. "You have a mutual-fund company that has actively traded funds, yet they would say 'buy and hold.' They invented the term, but never really practiced it themselves."

Hefty, who manages $135 million at the Auburn, Ind.-based Cornerstone Wealth Management, relies on a combination of fundamental and technical analysis instead, with predetermined entry and exit points. Hefty doesn't mind if his returns aren't the alpha of the alpha, as long as he gets a piece of the rally.

He offered up a slogan he considers superior to "buy and hold": "Advance and protect."

-- Written by Lauren Tara LaCapra in New York

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