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Keep faith in buy-and-hold

February 24th, 2009 · 21 Comments

If you are tired of the endless chatter in the media questioning the wisdom of buying-and-holding stocks and comparisons to the Great Depression, you might find the following passage in the Introduction of The Intelligent Investor to be of interest:

There are no sure and easy paths to riches on Wall Street or anywhere else. It may be well to point up what we have said by a bit of financial history — especially since there is more than one moral to be drawn from it. In the climactic year 1929 John J. Raskob, a most important figure nationally as well as on Wall Street, extolled the blessings of capitalism in an article in the Ladies’ Home Journal, entitled “Everybody Ought to Be Rich.” His thesis was that savings of only $15 per month invested in good common stocks — with dividends reinvested — would produce an estate of $80,000 in twenty years against total contributions of only $3,600. If the General Motors tycoon was right, this was indeed a simple road to riches. How nearly right was he? Our rough calculation — based on assumed investment in the 30 stocks making up the Dow Jones Industrial Average (DJIA) — indicates that if Raskob’s prescription has been followed during 1929-48, the investor’s holdings at the beginning of 1949 would have been worth about $8,500. This is a far cry from the great man’s promise of $80,000, and it shows how little reliance can be placed on such optimistic forecasts and assurances. But, as an aside, we should remark that the return actually realized by the 20-year operation would have been better than 8% compounded annually — and this is despite the fact that the investor would have begun his purchases with the DJIA at 300 and ended with a valuation based on the 1948 closing level of 177. This record may be regarded as a persuasive argument for the principle of regular monthly purchases of strong common stocks through thick and thin — a program known as “dollar cost averaging.”

I ran the same study for rolling 10- and 20-year periods starting in 1970 using the total real (i.e. inflation-adjusted) returns of the TSX Composite, S&P 500 and MSCI EAFE indexes in Canadian dollars and some of the results might surprise you. Details will posted next week.

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21 responses so far ↓

  • 1 Is buy and hold investment strategy dead? | Financial Highway // Feb 25, 2009 at 1:34 am

    [...] Related : Canadian Capitalist Keep Faith in buy-and-hold [...]

  • 2 Blogging About Money // Feb 25, 2009 at 1:37 am

    Just for argument’s sake, can you please include Japan in the evaluation as well?

  • 3 Blogging About Money // Feb 25, 2009 at 1:38 am

    What I mean is, as a separate investment (outside the scope of the EAFE).

  • 4 Dividend Growth Investor // Feb 25, 2009 at 4:20 am

    BAM,

    I was also thinking about Japan for the 20 year period 1989-2009. The main issue is that I can’t seem to find any dividend data for Japanese Stock Indexes such as Nikkei 225 for a period of 20+ years.

    If I could paraphrase Nassim Taleb, everything is possible. However it is also possible that stock market returns of the next 10 years mirros the stock market returns in the 1990s.

  • 5 Four Pillars // Feb 25, 2009 at 8:27 am

    Looking forward to the results.

    What gets me is people who only look at the index number when talking about how long it takes for equity investors to recover their investment after a crash which ignores dividends.
    The other thing is that by cherry-picking time periods they assume someone bought their entire portfolio at the height of the market.
    Unlikely scenario.

  • 6 Doug // Feb 25, 2009 at 9:20 am

    http://www.nytimes.com/2009/02/07/business/07charts.html?_r=3&ref=business

    The decade ending last January was the worst in the 82 year history of the S&P500. People often use 1929 as a reference point. However, 1929 data often don’t include the greater than 25% deflation of the Depression and reinvested dividends. Dividends were greater back then than they are now. For further information, please use the above link.

  • 7 Canadian Capitalist // Feb 25, 2009 at 11:57 am

    Blogging about Money: I did manage to find data for Nikkei 225 in local currency but I don’t have dividend data. Without dividend data, we can only have an incomplete picture.

    Dividend Growth Investor: My understanding is Japanese equities traded at sky high valuations and ultra low dividend yields in the 80s. It is hardly surprising that Japanese equities have had 20 years of poor returns.

    The effect of high valuations can be observed in the S&P 500 as well. The “lost decade” is partly due to sky-high valuations of the late 90s, which fortunately didn’t reach Japanese bubble levels.

    Mike: It is meaningless to look at stock return data without including dividends. That’s a bit like saying an investor purchased a 20-year bond in 1985 and simply got back the principal in 2005, without saying that they received double-digit interest payments in the meanwhile. It is especially egregious to ignore dividends prior to 1950s when dividend yields exceed bond yields.

    Doug: I’m running numbers by assuming that an investor puts $1,000 in real dollars at the beginning of each year. The results (in real C$ terms) for the S&P 500 for the recent past is not pretty but I’d argue that 10 years is still not what I would consider “long term”. Also, investors would have done reasonably well in Canadian stocks and EAFE stocks.

  • 8 Ray // Feb 25, 2009 at 12:32 pm

    Four Pillars: I agree that many forget to take into account the dividends when looking at crashes, but there have been record levels of dividend cuts recently.

  • 9 EconStudent // Feb 25, 2009 at 1:10 pm

    About the Intelligent Investor, its main theme to investors as interpreted by Warren Buffett is that the main concern for every investor is margin of safety.

    I want to hit myself with the Intelligent Investor and repeat margin of safety, margin of safety, margin of safety…

  • 10 CanadianSmallCap // Feb 25, 2009 at 2:08 pm

    What I like about buy-and-hold is that it tends to match what the average investor can do. Investors have to find an investment strategy that matches their skill level and desire to get their hands dirty . Even if someone could prove that the best investment strategy for the long-term is to daytrade good micro-cap companies, I do not think that most investors should implement it.

  • 11 Canadian Capitalist // Feb 25, 2009 at 2:28 pm

    EconStudent: Since I’m mostly indexed these days, I get more value out of Chapter 8 (stock market fluctuations) than Chapter 20 (which introduces the concept of margin of safety). Still, I wonder if MoS has some implications for indexed investors. Perhaps, investors should hold off on purchasing stocks until they receive a “reasonable” premium from equities? I always thought if earnings yield from equities is better than bond yields then stocks are a reasonable buy by virtue of the fact that stocks have a growing earnings coupon but bonds don’t. But this clearly didn’t work in 2007 when stocks still yielded better than bonds but would have worked well in 1999. Perhaps, investors should demand a 2% to 3% premium for investing in stocks with the understanding that this may not always work (earnings might drop off precipitously). Thoughts?

  • 12 Dividend Growth Investor // Feb 25, 2009 at 2:43 pm

    CC,

    I agree that the main reason why Japanese and US markets had poor performance the past decade is because valuations were super rich. The thing to buy a decade ago have been CD’s ( certificates of deposit, not the music CDs :-) )

  • 13 EconStudent // Feb 25, 2009 at 3:57 pm

    CC: A reasonable risk premium is what Bogle suggests every investor to do.

    Jeremy Grantham says that it is easier to see overvaluation between asset classes than between stocks. William Bernstein pointed out that rebalancing between asset classes is a good way of increasing long run returns. Efficient market hypothesis says that it is very difficult for investors to pick a group of stocks and beat the market, but it might be different in the case of asset classes where it is possible to overweigh undervalued asset classes beat the average return of the global stock market.

  • 14 Daniel Kozimor // Feb 25, 2009 at 6:09 pm

    >There are no sure and easy paths to riches on Wall Street or anywhere else.

    The world would be a better place if this statement was commonly understood.

  • 15 EconStudent // Feb 25, 2009 at 6:57 pm

    Daniel: Good point. So what should we do instead? Putting every thing we earn into a saving account or T-bills, because the long run risk there is that we might under perform inflation. Oh wait. Real Return Bonds. That might be a solution.

    I think indexing is good, since it removes the more speculative nature of picking individual stocks. Understanding different asset classes is good too, since the efficient market hypothesis doesn’t apply there at the highest level. For a person near retirement, bonds need to be the majority of the portfolio. Ben Graham recommended 25% equity/ 75% bond portfolio for those who has lower risk profiles. I guess that is the case seventy years ago and is still the case now.

    I don’t know. What do you think?

  • 16 gene // Feb 25, 2009 at 9:30 pm

    I haven’t seen such a blatant cliff-hanger since “Who shot JR?”. Well, maybe since “Who shot Mr. Burns?”.

    I recall somewhere in “The Intelligent Investor” where Graham has some condition whereby equities will very likely outperform bonds, but I don’t recall the exact condition. It was perhaps something about comparing corporate bond yields to dividends.

  • 17 moneygardener // Feb 26, 2009 at 9:23 am

    It annoys me every time I see the BNN commercial where Michael Hainesworth asks somebody:

    IS BUY AND HOLD DEAD?

    This is rediculous. Of course people are asking these questions at this time in the market cycle. That is like asking IS THERE ANY EASIER WAY TO MAKE MONEY THAN IN THE STOCK MARKET? ..during an exuberant bull market.

  • 18 Canadian Personal Finance Blog » Blog Archive » Random Thoughts // Feb 27, 2009 at 8:32 am

    [...] Canadian Capitalist advises us to Keep Faith in Buy and Hold, which I think is important to remember, even with recent [...]

  • 19 Results of Dollar Cost Averaging for the TSX Composite // Mar 3, 2009 at 12:55 am

    [...] their savings gradually over time. After reading a passage in The Intelligent Investor on how such a dollar cost averaging strategy performed during the Great Depression, I was curious to see how it would have performed in recent [...]

  • 20 John Jacobs // Mar 6, 2009 at 5:41 am

    People always talk about the Japanese lost decade but they fail to mention that Japanese companies just aren’t that exciting. Besides high valuation, most Japanese companies have low ROEs (ask yourself why Buffett has avoided Japanese companies). There is something to be said about investing in ’strong companies.’

  • 21 Investors behaving badly — Canadian Capitalist // May 7, 2009 at 9:14 am

    [...] The DALBAR update isn’t surprising. The QAIB has consistently shown a large gap between the returns investors actually earn and the return they could have easily earned with a buy-and-hold strategy. [...]

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