Mark Hulbert
Share World
What a difference two months can make. As recently as this summer, the debate between market timers and buy-and-hold investors was all but dead.
After all, this year was shaping up as yet another in which virtually no market timers – investors who try to jump in and out of stocks at the most opportune moments – were doing better than the overall market.
But with the broad United States market down 20% from its midsummer highs, buy- and-hold investors are having their faith tested.
How should you decide whether to time the market? Begin by acquainting yourself with the statistical case against it: fewer than 20% of market timers are able to beat a buy-and-hold strategy on a risk-adjusted basis.
Buy-and-holders, however, mistakenly consider the matter to be solely about statistics. Investors don’t throw in the towel at the wrong times because they are ignorant of the data; they do so because they can’t take the psychological pain.
The lesson, of course, is that you shouldn’t wait until the bottom of the next bear market to discover that you’re a closet market timer. After all, investors who try to execute a buy-and- hold strategy but lose nerve at the bottom will likely be worse off than investors who pursue a thoughtful market-timing strategy that looks inferior on statistical grounds.
Latter-day converts to the buy-and- hold strategy assure me that they won’t be foolish and throw in the towel in a bear market. But I don’t believe them. The only investors who could convince me are those who were fully invested in late 1974, at the bottom of the last severe bear market. And there are precious few of them. All the other buy-and-holders either aren’t telling the truth or are too young to have anything more than hope about how they will behave in the next bear market.
Why is it so psychologically difficult to stay fully invested when it’s clear statistically that most investors would be better off in the long run if they did? A main reason is that the long run is much longer than the typical investor’s attention span.
Ask yourself this: how long do you think you must hold your stocks to be assured that you’ll at least stay even with riskless US treasury bills? Five years? Not good enough.
According to Professor Jeremy Siegel at the Wharton School of the University of Pennsylvania, stocks failed to keep pace with inflation in 25% of the rolling five-year periods since 1802. The situation is barely better when investors hold on for 10 years; 20% of those periods failed to keep up with treasury bills.
In fact, to get the failure rate down to 5% – a benchmark for an acceptable bet – investors must be willing to hold stocks for more than 20 years. No wonder so few investors have sufficient staying power to buy and hold.