Under what circumstances should an investor consider a buy-and-hold ("B&H") strategy? This is the popular method for a vast majority of financial pundits, brokers, bankers and advisers ("FBB&A"). In many instances FBB&A keeping their clients fully invested increases the odds they will be paid commissions and broker fees. They even use claims that you can’t time the market so you have to accept the ups and downs. Market unpredictability is a valid point, but the reality is that each investor needs to evaluate their own risk tolerance before accepting this roller coaster mentality for their investments. So is accepting the industry B&H dogma best for you?
For a long-term investor looking to accumulate wealth, generating an income stream and handling the potential volatility with periods of significant declines, then a B&H strategy may be right for you. Conversely, if you were mentally shaken because of the substantial downdrafts of the market of over 30% twice in the last 14 years or want to protect your principal, then a risk management strategy might be more appropriate for you to consider.
So how does an investor know what is the best course of action for their particular situation? To be a B&H investor you must realize that there are no age limits to apply this philosophy. An 80 year old investor might be able to handle the risk associated with applying a B&H strategy while a 30 year old may not.
The determining factor is to focus on the investor’s psychological DNA for accepting risk. If the belief that any decline in the value of their portfolio as a result of economic, geopolitical or other factors beyond the normal course of a business cycle is temporary and / or a “buying opportunity” then they have a penchant for risk. The stronger they are to handle those factors, the more accepting it will be to become a B&H investor. They reveled in recent market history which saw two horrific downturns (March 2000-January 2003 and October 2007 through March of 2009) because of significant shocks outside the normal course of economic reality.
So what was your mindset and investing philosophy during those periods? Were you looking for opportunity? Did you focus on your goals and objectives, not the fluctuations in the market? Are you a believer in the long-term viability of the economy and market? The answer would be “Yes” if you are an advocate that over the next five to ten years things will get better and you can weather similar storm clouds of the past with some, but not apocalyptic, concern.
I feel that viewing these events as temporary over an investing time horizon no matter the age of the investor will allow them to maintain a high level of psychological DNA. Therefore, it is not out of the realm for you or any investor to be a true B&H investor if the profile has been matched. Dovetailing the concept, an investor that has a specific goal and objective that needs time to achieve the desired results may also be a candidate to have their money managed via B&H philosophy. Some examples of such may be an investor that is in the long-term wealth accumulation phase to fund the purchase of a home or pay for college education. It could also be an investor who is looking for a cash flow stream to be distributed to offset retirement living expenses or to fund the mission of a foundation / endowment. Examples such as these highlight what may constitute a perfect candidate of a B&H investor.
Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.