Wednesday, November 30, 2005

REAL RETURN STRATEGIES IN PLACE OF BUY AND HOLD STRATEGIES.

WHY MAKE MONEY TODAY WHEN YOU JUST MIGHT MAKE SOME MONEY TOMMORROW?

The Author is a frequent critic of the “buy and hold” investment strategy. The buy and hold strategy involves buying stocks and/or mutual funds and holding them for long periods of times. Although the value of these investments will fluctuate, if you hold them for a relatively long period of time, they will grow in value. This investment approach, like all investment approaches, has both positive and negative aspects. Being polite, the Author will start with the positives of the “Buy and Hold Strategy”.

Positive Aspects of the “Buy and Hold” Strategy:
1. Low Transaction Costs. Since the strategy does not involve frequent purchase and sales of investments, the transaction costs are minimized. But with online brokerage services, transaction costs are usually minimal.
2. Eliminates Investor Propensity to “Buy High, Sell Low”. Many investors, because of lack of confidence or observed human nature, chase performance and buy investments at or near their peak. And they often sell when the price falls, missing the next rally.
3. Broker Convenience. Buy and Hold is simple for brokers to sell and support. The broker manages the client relationship, not the client’s money.
4. When the Markets are Bullish, the Strategy Usually works. Ask anyone who invested into the Secular Bull Markets of 1946 to 1966, or 1982 through 2000.

Negative Aspects of the “Buy and Hold” Strategy:
1. It Fails in a Secular Bear Market. As readers of this website know, the stock markets are in a Secular Bear Market cycle that began in 2000 and may run into the next decade. Secular Market cycles, Bear and Bull, run an average of 18 years. So we could be faced with low or no overall market returns through perhaps 2018.

“Buy and Hold” fails in a Secular Bear Market for two main reasons. First, you are holding a lot of stock in a Bear Market. If you tell a broker, financial planner, or mutual fund sales person that you want to invest for retirement or some other long-term goal, you will usually be advised to invest in stocks. You will be told that “over the long term”, stocks outperform other investors. That is true if your investment period includes a Secular Bull Market. But if you invested in 1966 and pulled out the money in 1982, your stocks under-performed other investments.

2. In a Secular Bear Market you are Often Stuck With the Wrong Stocks. You broker or financial advisor will also tell you that since you are a long-term investor, you should concentrate your holdings in growth stocks. Over time, these stocks will outgrow value stocks. Again, in a Secular Bull Market, growth stocks will out distance value stocks. But not in a Secular Bear Market. The investor gets the worst² (squared). He holds the wrong class of stocks in a period of time when he generally should he limiting his stock exposure.

A TRADITIONAL BUY AND HOLD STRATEGY CREATES A LOSE-LOSE SCENARIO IN THIS SECULAR BEAR MARKET.

If holding growth stocks for the long-term during this Secular Bear Market is a lose-lose proposition, what can you do that works? First, you must resign yourself that earning positive returns will take more work and still produce poorer results than you can earn during a Bull Market. Face the fact you will work harder and earn less. Think of it as your investments and your investing efforts being underemployed.

The proper strategy to employ in a Secular Bear Market is an Absolute, or Real Return Strategy. We want to make money year in and year out. We should find no comfort in the fact that our portfolio only lost 3% when the S&P 500 was down 5%. That is like winning a law suit but going broke paying legal fees.

Remember the lesson from the last post about negative returns and their effect on total returns? Negative returns are killers, especially in a Secular Bear Market. Even if you only squeak out three or four percent a year during the Bear Market, you will be making investment progress. You will be building, albeit more slowly, your wealth platform for the days when the Secular Bull Market is back. And remember, even within long Secular Bear Markets, there will be Cyclical Bull Markets that will provide you with nice returns over a short period of time.

The Author has provided some strategies in prior posts and newsletters. More cash, value stocks, high dividend stocks, and short investments when the markets are in confirmed declines. Gold and commodities may also have their place. In the next couple of posts, we will look at some ideas to move toward absolute return strategies.

FOR RIGHT NOW WE WILL HAVE TO TRUDGE ALONG IN THE RUTS IN THE DESERT OF THE REAL!

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