It is always interesting to review comments of the work that is done under the "Daily State of the Markets" banner. On Friday, the long-standing question of active investing (i.e. employing a buy and sell approach) versus passive investing (buy and hold forever) was explored. And as expected, the topic did indeed create quite a debate.
While Friday's missive clearly backed the "active" side of the argument, this is not to say that buy-and-hold/hope is universally a bad idea. The problem is that the vast majority of investors simply cannot stomach such an approach. But one reader made an argument that is worth exploring.
Buy-and-Hold Done Right
Below is an unedited comment from a reader of "Daily State of the Markets" on SeekingAlpha.com...
"I come from a family of buy and hold investors. By buying the dividend aristocrats when they were cheap and then never selling them, my mother was able to turn a fifty thousand dollar investment into a portfolio worth over ten million in 40 years. I have been buying and holding the dividend aristocrats since 1970. I am not as good at investing as my mother and made some foolish mistakes by buying an occasional high flyer, but my returns over the long term have been almost as good as hers. Yes, my portfolio lost fifty percent of its value in 1974 and 2002 and 2008. Big deal. Over the long term, I am way way ahead. Buy and hold is definitely the way to go if you want to get rich over the long term."
Quite frankly, the argument presented makes a lot of sense. First off, kudos to this investor for having a strategy. This was one of the key points made in Friday's article. Step one to succeeding over the long-term in the stock market is to have a strategy. And the strategy employed by this reader is a pretty good one.
The "dividend aristocrats," strategy is defined by Standard & Poors as buying companies in the S&P 500 that have increased their dividends every year for the past twenty-five consecutive years. And yes, fans there is an ETF for that: ProShares S&P 500 Aristocrats (NOBL).
According to S&P, the average annual return for their Dividend Aristocrat index over the five-year period ending October 25, 2013 was 20.96% per year. Granted, this period began near the depths of the "credit crisis" bear market (S&P 500 on 10/24/2008: 908.11) - so the example benefits from "buying low." And it is worth noting that this was generally a bull market period. However, the strategy has beaten the S&P 500 handily.
Over the five-year period ending Friday, October 25, 2013, the S&P 500 cash index has advanced a total of 93.8 percent - or 14.0 percent per year. By contrast, the S&P Dividend Aristocrat index's average return of 20.96 percent per year would have produced a total return of 158.9 percent. Impressive!
Paying the Price - OUCH!
However, as the reader points out, he and his Mom did have to sit through the brutal bear markets that occurred in 1974, 1987, 2000, and 2008. And three of those bears produced losses in excess of 50 percent. So, before you decide to become a long-term buy-and-holder this morning, ask yourself a very important question: Can you live with that?
Be Like Buffett
One way to combat the misery of bear market periods, which, quite frankly, don't occur very often (there have only been three major bear markets since 1980) is to "be like Buffett."
As you are no doubt aware, Warren Buffett is one of the greatest investors of all time. One of the keys to his success (other than buying companies that are undervalued and businesses he "understands") has been to buy when there is blood in the streets. If you will recall, it was Buffett that stepped in and helped prop up Goldman Sachs during the height of the credit crisis debacle. Sure, he was early on the move and GS went a lot lower after his purchase. But in the long run, buying when everyone else is selling has been a fabulous strategy.
A Better Way To Play
The question, of course, is how can the average investor play the game like Buffett does? Obviously, the little guy can't extract high rates of return from Goldman Sachs at the height of a crisis. No, the average investor has to play the game differently.
One way to improve the buy-and-hope strategy would be to understand the historical cycles of the stock market and then to be ready to buy when everyone else is scared and selling. While the following stats are based solely on memory and are NOT exact, it is important to recognize that, on average, severe corrections (a decline in the S&P of 10 percent or more) happens in the stock about once a year or so. Next, recognize that an average bear market (a decline of 18-20 percent) tends to occur every three to five years. And then a major bear market, which produces losses in excess of 30+ percent, happens about (key word) once a decade.
So, the way to beef up the buy-and-hope strategy involving the Dividend Aristocrats would be to focus on "buying like Buffett." For example, one plan would be to:
- Accumulate cash on a monthly basis to be ready for "opportunities"
- Invest a portion of the cash each time the S&P drops 10% or more
- Invest an additional amount each time there is "blood in the streets"
In case it isn't obvious, the key to this approach is to have cash available to deploy during corrections and bear markets. Thus, an investor would need to regularly accumulate cash for this purpose and then "deploy it" with discipline.
Nothing is Easy in This Game
However, it is important to recognize that NOTHING is easy in this game. You WILL be very uncomfortable each and every time you deploy your hard earned cash into a market decline. You will also feel VERY uncomfortable when you watch the market go lower after you've made a purchase. In short, one has to understand the game and the game plan being employed.
The key is to understand that this approach isn't about trying to "buy THE "low"... It's about simply "buying low." Over time, adding shares into a decline means that you have more money working during the next bull run. And it is vital to remember that no matter how bad things feel at the time, there WILL be a next bull run!
So, while there are lots and lots of "active" strategies that can beat the market most of the time, adapting a "buy-and-hope" approach using the "Dividend Aristocrats" isn't a bad way to go for investors who only want to get involved in the game when the time is right.
Turning to this morning... Despite upbeat sessions in Japan and Hong Kong, traders in the U.S. and Europe are a bit nervous in front of a big week of earnings (24% of S&P 500 reports this week including Apple after the close today), economic data, and an FOMC meeting. As such, it isn't surprising to see a bit of trepidation in the early going.
Positions in stocks mentioned: none
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