Buy-and-Hold: Golden Strategy That Takes an Iron Will
Anne Scheiber's life was no happy tale. Embittered after the federal government failed to promote her from her IRS auditing job at the end of 1944, she retired and spent the next 51 years mostly alone, living on the Westside of Manhattan.
Her only hobby was investing. She apparently put every penny she had into stocks, rarely selling, her broker would later explain.
By the time she died in 1995, Scheiber had amassed a $22-million fortune in about 100 stocks--all of which she left to a stunned, but grateful, Yeshiva University.
If Scheiber's story is something of a cliche--"aged, frugal recluse buys and holds stocks, leaves millions to charity"--it's too bad we all can't be beneficiaries of such cliches.
But then, many investors have in fact benefited handsomely in the 1990s from the same basic investment philosophy: Just buy stocks and don't sell them. Period.
The proven long-term success of buy-and-hold is the basis for the retirement savings plan boom of the past decade, of course. Americans are encouraged to invest regularly in the market, avoid the temptation to sell when stocks suddenly sink, and trust that when retirement happens in 10, 20 or 30 years, a hefty nest egg will be there to fund it.
And why doubt that? Since Dec. 31, 1989, the Dow Jones industrial average has risen 192%, from 2,753.20 to 8,031.22 at Friday's close.
Even better: Measured from the start of the 1980s bull market on Aug. 13, 1982, the Dow has increased a spectacular tenfold.
What's more, if buy-and-hold still is good enough for Warren Buffett--perhaps the greatest living spokesmodel for that investment style--it still should be good enough for the rest of us, right?
Yet as stock prices have zoomed this year, adding to the huge gains of 1995 and 1996, many investors have understandably grown uneasy. The nagging worry is that stocks might have reached such historically high levels that buying and holding at these prices may never pay off.
On days like Friday--when the Dow sank 156.78 points, or 1.9%, as bond yields surged on concerns about the economy's growth rate--investors' darkest concerns about the market's future can surface.
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Is there a danger in trusting buy-and-hold at this point?
Certainly not if you have 51 years, like Anne Scheiber did. Academic studies show that the longer your time horizon, the lower the possibility of losing money in stocks.
That's not terribly surprising: Over time, the economy's natural tendency is to grow, because humankind's tendency is to strive to achieve more. If you own stocks, you own a piece of the economy--so you participate in its growth.
But over shorter periods--and that includes periods as long as a decade--it is indeed possible to lose money in stocks. Consider: The Dow index was at 890 on Dec. 31, 1971. Ten years later, on Dec. 31, 1981, the Dow was at 875. Your return after a decade of buy-and-hold was a negative 1.7%.
True, the 1970s were a miserable time for financial assets overall, as inflation soared with rocketing oil prices, sending interest rates soaring as well. But we don't even have to look back that far to discover just how difficult it can be to stick with a buy-and-hold strategy.
From the late 1980s through 1991, major drug stocks such as Merck & Co. and Pfizer Inc. were among Wall Street's favorites. They were well-run businesses, and the long-term demand for their products seemed assured.
By December 1991, Merck was trading at $56 a share, or a lofty 31 times its earnings per share that year.
Then came the Clinton administration's push for national health care. Suddenly, the drug companies found their pricing policies under attack. The stellar long-term earnings growth that Wall Street anticipated seemed very much in doubt. And the stocks fell into a decline that lasted more than two years and which shaved 40% to 50% from their peak 1991 prices.
Merck, for example, bottomed at $28.13 in 1994, which meant a paper loss of 50% for someone who bought at the peak in 1991.
If that had been you, could you have held through that horrendous decline? You should have: Today, Merck is at $98.81 a share, or 76% above its 1991 year-end level. After restructuring its business, Merck's earnings began to surge again in 1995 and 1996.
And this year, the drug stocks have once again become market darlings. But therein lies the problem: Merck is again trading for a high price-to-earnings ratio--26 times estimated 1997 results.
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That doesn't necessarily mean that Merck is primed to drop 50%, as it did in 1992-94. But it does mean that if you own that stock--any stock, for that matter--you must allow for the possibility of a deep decline from these current high levels, something much worse than the just-short-of-10% pullbacks the market has experienced twice in the last 14 months.
Anne Scheiber, angry recluse that she was said to be, somehow managed to show no emotion at all about the stock market's many ups and downs in her 51 years of investing. A cynic might say she had nothing on which to spend her money, anyway. But the point is, she managed to remain true to buy-and-hold, when many other investors were probably selling out at the market's lows.
Mark Hulbert, editor of the Hulbert Financial Digest newsletter in Alexandria, Va., and a student of market history, worries that too few investors will have Scheiber's iron stomach when the tide eventually turns for the market overall, as it did for the drug stocks in 1992.
"I am cynical about all of these people genuflecting at the altar of buy-and-hold," Hulbert says. "They're not buy-and-hold--that's just what is working now," so investors are happy to go with the flow, he says.
Most investors, Hulbert maintains, are too new to the market to imagine how psychologically painful a major and sustained loss in their portfolio would be.
What is key to judging how much of your assets should be in stocks is your tolerance for risk, your tolerance for loss and, of course, your time horizon. But as a simple rule of thumb, many Warren Buffett disciples like to use this line: If, for whatever reason, you can't take a temporary, 50% loss in your portfolio, then you don't belong in the stock market.
For the relative handful of pros who really invest like Buffett, what the market does on a short-term basis isn't important. Their faith in buying and holding stocks derives from their long-term faith in the underlying businesses.
George Mairs, the 69-year-old manager of the $324-million Mairs & Power growth stock fund in St. Paul, Minn., owns just 33 stocks in the fund. He is among the least active traders in the fund business--he almost never sells. And his results speak for themselves: Mairs & Power Growth has beaten the Standard & Poor's 500 index every year in this decade.
Does Mairs fear that buy-and-hold isn't a great idea at these market levels? Hardly. High-quality stocks aren't cheap, he says, but neither does he find them to be drastically overpriced. "It's the long-term earnings stream that we look at," he says. "If the earnings are going to be there, we don't worry too much.
"What we want to do is own businesses," Mairs says. "If we like a business for the long term, we don't worry about what the stock value is on a week-to-week basis."
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How Patient Can You Be?
"Buy and hold" sounds great on paper, but it can require enormous patience. Major drug stocks, for example, soared 94% between March, 1990 and December, 1991, as measured by the Standard & Poor's index of five major drug companies. But when the threat of federalized health care surfaced in 1992, drug stocks began a sustained decline that lasted more than two years--and slashed the S&P drug index by 42%. With the stocks again rocketing this year, 1992-1994 stands as a sobering reminder of how bad things can get. S&P drug stock index, quarterly closes and latest
Source: Bloomberg News
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