Buy And Hold Investing. Is It A One Size Fits All Solution?
2022.05.06 12:55
investing. Is it truly a to the investing conundrum? Or are there other considerations that would make such a solution less optimal?
I ask the question due to an email I received recently from one of the large Wall Street firms.
As shown in the chart below, the advice given is not entirely wrong. Since 1900, the markets have averaged roughly 10% annually However, that figure falls to 8.08% when adjusting for inflation.
S&P 500 Total Real and Nominal Return
By looking at the chart above, it’s pretty evident that you should invest heavily in the market and
If it was only that simple.
Two Important Problems
While the average rate of return may have been 10% over the long term, the markets do not deliver 10% every year. Let’s assume an investor wants to compound their returns by 10% a year over 5-years. We can do some basic math.
Math Of Loss 10pct Compound
After three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required.
There is a significant difference between AVERAGE and ACTUAL returns. The impact of losses destroys the annualized effect of money.
To prove that, the purple shaded area shows the return of 7% annually. However, the differential between the promised and “ is the return gap. See the problem?
Promised vs Real Returns
The differential between what investors were promised and actual returns are substantial over the long term.
Secondly, and most importantly, you DIED long before you realized the long-term average rate of return.
The chart box below shows a $1000 investment for various starting periods. The total return holding period is from 35-years until death using actuarial tables. There are no withdrawals. The of 6% annualized compound returns is the orange sloping line. The black line represents what occurred. The bottom bar chart shows the surplus, or shortfall, of the 6% annualized return goal.
Life Expectancy 6pct Returns Time Frames
At the point of death, the invested capital is short of the promised goal in every case except the current cycle starting in 2009. However, that cycle is yet to be complete, and the next significant downturn will likely reverse most, in not all, of those gains.
The Problem With Long-Term
Such is why using or rates of return in financial planning often leads to disappointment.
Let’s consider the following facts in regards to the average American. The national average wage index for 2020 is $55,628.60, lower than the $62,000 needed to maintain a family of four today.
- 61% of consumers are living paycheck-to-paycheck
- 42% of consumers earning more than $100,000 struggle to make ends meet.
- 56% of Americans can’t cover a $1000 emergency with savings
- 50% of American households have NO retirement savings
Assuming that the average retired couple will need $40,000 a year to live through their they will need roughly $1 million, generating 4% a year in income. Since approximately 90% of Americans have saved less than one to two years of annual income, funding retirement could be problematic.
While many suggest the investing will work over the long term, for most, that period is roughly 15-20 years until retirement.
Here is the problem.
There are periods in history where returns over 10-year periods were negative.
SP500-Real Total Forward Returns vs Valuations
The return has everything with valuations and whether multiples are expanding or contracting. As shown in the chart above, real rates of return rise when valuations expand from low to high levels. But, real rates of return fall sharply when valuations have historically exceeded 23x trailing earnings and revert to their long-term mean.
Yes, investing will work, but it depends on WHEN you start your investing journey. At 35x CAPE, such suggests that returns over the next 10-20 years could be disappointing.
Valuations Forward 10-Year Returns
Timing Is Everything
The MAJORITY of the returns from investing came in just 5 of the 9-major market cycles since 1871. Every other period yielded a return that lost out to inflation during that time frame.
SP500 Long-Term Valuations
With this in mind, this is where the email went awry with selective data mining:
SP500-Chart-2007-2010
The main problem is selecting the start and ending period of October 2008 through March 2010. As you can see, the PEAK of the financial market occurred a full year earlier, in October 2007. Picking a data point nearly 3/4ths of the way through the financial crisis is egregious.
It took investors almost SEVEN years to get on an
Every successful investor in history, from Benjamin Graham to Warren Buffett, has particular investing rules that they follow. Yet Wall Street tells investors they can NOT successfully manage their own money, and investing is the only solution.
Why is that?
More importantly, if it worked as stated, why are 80% of Americans broke instead of rich?
Buy And Hold Works, Until It Doesn’t.
“buy and hold” investing works well during strongly trending market advances. Given enough time, the strategy will endure the eventual market downturn. However, three key considerations must get considered when endeavoring into such a strategy.
Suppose valuations are high at the beginning of the investment journey. If the time horizon is too short or the required rate of return is too high, the outcome of a strategy will most likely disappoint expectations.
Mean reverting events expose the fallacies of “ investment strategies. The is NOT the same as a and losses devastate retirement plans.
Therefore, during periods of excessively high valuations, investors should consider opting for more strategies with the goal of capital preservation.
Important Points To Consider
Before engaging in a investment strategy, the analysis reveals essential points to consider:
- ,
There is no
Every investor must account for the myriad of variables that will impact their investment returns and financial goals over time. Most importantly, investors must realize that surviving the eventual bear market is more important than chasing the bull market.
The is navigating the entire market cycle between when you start investing and when you need your capital.
strategies are the ” to invest until they aren’t.
Just make sure you know where you are within a given market cycle to increase your odds of success.
