You Must Be an Active Investor: “Buy and Hold” Never worked

Posted on June 3rd, 2009 by admin in Quant

We have written that the “buy and hold” paradigm (i.e., passive investing) promulgated by the brokerage industry really doesn’t work. (You can see the many posts on this by clicking on the “How to Invest” or “Quant” category archives.). In this post, we’ll show some new empirical research making the point very powerfully.

There are many ways to demonstrate this quantitatively, but some of the most elegant proofs are based on observing how you improve your investment returns if you are out of the market sometimes and in it sometimes–at the right times! The point is that those times must be chosen, and thus you are an active (as opposed to passive) investor. Here’s a really simple example of such research which we first read in Forbes Magazine, 11-24-08. It’s written by Laszlo Birinyi, “Uncharted Waters”. He says:

“Assume you had invested $1 at start of the bull market in 1966 and ignored dividends. If you missed the:

  • Five best days of each year, investment now = $1.11.
  • Five worst days each year, investment now = $2,696.”

This certainly shows it pays to be out of the market sometimes. Those times must be chosen, so that makes you active.

Now we are ready for a much more powerful version of this approach. Theodore Wong has recently published a study of the market for the last 137 years. We provide the original here:

What_the_missing_out_argument_misses

Wong concludes with this question:

“If you could help your clients avoid most of the bear markets, would they mind missing a few mighty rallies?”

We think both the studies presented here compel us to actively evaluate the market situation and take appropriate action, rather than passively buying and holding.

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