In this episode, we’ll learn more about the importance of following a buy-and-hold strategy when investing for your long-term goals. Investing is not meant to be a game of chance; rather, it’s a practice of patience and strategy. Fran Kinniry of Vanguard’s Investment Strategy Group explains what the phrase “buy and hold” means, and importantly, what it does not mean.
Fran Kinniry: Buy-and-hold strategy can mean different things to different people. It has come under pressure recently in the press, as it relates to “Set it and forget it.” So really, buy and hold is much different than “Stay the course.” Stay the course, we believe, is having an asset allocation, and as the capital markets move, rebalancing the portfolio back to that target allocation.
Narrator: Re-balancing should be a part of any investor’s long-term portfolio. By periodically taking a careful look at your portfolio—giving it a kind of “reality check”—you can ensure that your portfolio remains true to your goals and risk tolerance.
Fran Kinniry: Re-balancing is a very important strategy, because how you align your portfolio between stocks and bonds is the primary determinant between risk and return. For investors who own individual mutual funds of stocks and bonds, as the capital markets move, action is required on their behalf to return the portfolio to their asset allocation.
Narrator: The unpredictability of the financial markets—exemplified by the steep decline of 2008 and early 2009—can drive even the most seasoned investors to make abrupt changes in their portfolios. Mr. Kinniry describes why investors shouldn’t let uncertainty deter them from their predetermined asset allocations.
Fran Kinniry: When we look at long-run performance, the equity market has a substantial return premium over bonds and money markets. For example, when we look at 20-year periods in history, the stock market has outperformed the bond market by over 90% of the observations in 20-year horizons; and if we move to 30-year horizons, we see the stock market outperforming 100% of the time over the bond market. Now, that is history; and certainly, that could be different in the future. However, we do know that the equity risk premium is large; and we also know that the probability of capturing that return premium increases with your time horizon.
Narrator: Recently, some investors may be looking at the adage “Buy low, sell high” purely as a buying opportunity for stock funds. However, as Fran suggests, the market upheaval is better viewed as an excellent opportunity for individuals to return their portfolios to the appropriate balance that meets their goals, objectives, and risk tolerance.
Fran Kinniry: We would use a word of caution on “Buy low, sell high,” or “It’s a buying opportunity because the market looks low.” What we really believe is important is investors set their asset allocation based on their goals, objectives, and risk tolerance. And certainly, what that means is if the capital markets—especially equities—go down, that investors would rebalance their portfolio by buying stock mutual funds. They’re not buying stock mutual funds because they see it necessarily as a buying opportunity.
Narrator: Some investors succumb to their emotions and attempt to time the market. The temptation to buy and sell shares—and jump in and out of the market—can wreak havoc on an investor’s portfolio, possibly even leading to lower-than-expected returns.
Fran Kinniry: It’s important to recognize that investing is a practice of strategy, patience, and understanding the probabilities of the market. Evidence suggests most investors who are going in and out of equity mutual funds, bond mutual funds, and money markets have tended to hurt their performance. We know this through many different research pieces that we’ve looked at. And so, more times than not, they’re acting out of emotion—and for the majority of the times, their decision to move out of different asset classes has not helped them in their total return.
Narrator: It’s important for investors to consider remaining in the market—even when their emotions tell them otherwise—to potentially benefit from an eventual market recovery. However, loss aversion can play into investors’ decision-making.
Fran Kinniry: First of all, it’s very emotional for investors to lose hard-earned savings, and so, the definition in our world is loss aversion. And what that means is that a dollar lost has much more significance to an investor than a dollar gained. It should be anticipated for investors to be concerned and to get emotional as they see their assets declining in value. We strongly encourage investors not to move in and out of the market. The belief of some is that you’ll know when the recovery has taken hold. History does show us, however, that often the recoveries occur unexpectedly. We saw this in 2002 and again in the early spring of 2009. So, often, investors miss the very strong early part of a recovery because there are no signs that it’s all clear to invest.
Narrator: A buy-and-hold, stay-the-course strategy is just as important for investors in retirement as it is for those building assets in their working years. Even retired investors need to consider keeping some portion of their portfolios in growth-oriented investments, such as stock funds.
Fran Kinniry: For older investors, the hope is that their asset allocation was prudent going into the bear market. What we mean by that is they should have had a balanced portfolio—maybe more bonds than stocks. The other thing to keep in mind is that being too conservative has its risks. So it’s important for investors to make sure that they still have some growth potential, such as equity mutual funds; but hopefully, at the same time, they have a balanced portfolio.
Narrator: Younger investors, who have a longer investment time horizon, can reap the benefits of a buy-and-hold philosophy. The longer time horizon can allow the benefits of compounding to help their portfolios.
Fran Kinniry: For younger investors, it’s really important to understand the equity risk premium. And what we mean is that, historically, equity mutual funds outperform bond mutual funds by about 4% per year and approximately by 6% or 7% per year over money market investments. And so, that compounding over a very long horizon can lead to substantial wealth creation and wealth differentiation.
Narrator: We hope this “Plain Talk on Investing” article has given you a better understanding about the benefits of following a buy-and-hold, or stay-the-course, investment strategy. I would especially like to thank Paul and Richard at TheFlipBoard.com for allowing us to reprint this podcast here for their audience.
Now, You might have noticed that this article is speaking about traditional securities investments like stocks and bonds. But, you can also apply this logic to real estate investments. Re-balancing, selling off unprofitable properties, acquiring larger, more profitable items and holding on to them for the long haul are essential strategies for a successful, well-balanced real estate portfolio. With interest rates at all time lows, I urge each and everyone of you to take a hard look at the properties you own and weigh them against the kind of success you want to have in this industry within the next 2 to 5 years. And simply hold on to them!
Thanks and happy investing!
-Richard
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