The Premature Funeral for the “Buy and Hold “Investing Strategy

2008 was the worst economic collapse since the Crash of 1929 and the Great Depression of the 1930’s.  There was literally no place to hide unless you were fortunate enough to be holding 100% cash.  Bonds, normally the buffer to stock market declines, fell in concert with stocks.  This catastrophic collapse has the Wall Street “Pundits” clamoring that the “Buy and Hold” strategy of investing is no longer relevant.  To the professional Money Managers, this is now a stock picker’s market.

The irony of this situation is that actively-managed mutual funds, the “stock pickers”, have historically been unable to match the returns of the indexes.  When a Manager has an extraordinary year and does beat the index, rarely is that performance repeated the following year.  In addition, the actively-managed funds have far higher fees and expenses than the index funds, less diversification and higher turnover ratios.  Turnover ratios measure the percentage of a fund’s holdings that a fund sells in a year. High turnover results in trading costs and capital gains, the burden of which is borne by you, the investor.  All this adds up to less money in your pocket.  It makes total sense that the money managers are advocating stock-picking and trading as opposed to buying and holding an index.  They make no money with indexers who hold their index funds.  There is no monetary incentive for them to recommend them.

Index Funds Should Comprise the Bulk of Your Core Foundation Portfolio

The key to accumulating wealth over time is to buy and hold a broadly-diversified, low-cost collection of no-load stock and bond index funds and cash.  Your greatest assets are time, patience and compound interest through dividend reinvestment.  Albert Einstein supposedly referred to compound interest as “the most powerful force in the universe.”  Although there is some debate over whether Einstein actually did say this, it is difficult to argue that the compounding of interest in one of the critical factors in creating wealth over time.  By reinvesting dividends, you are buying additional shares with your income.  Your interest is added back to your principal, so from that point on, you are earning interest on interest due to the higher number of shares.  The longer your shares are permitted to compound, the greater the potential for wealth accumulation  in your portfolio.

Currently, there are three kinds of Index funds, market-capitalization based funds, fundamental-based funds and Exchange-Traded funds ( ETF’s).  Market-capitalization is determined by simply multiplying the number of outstanding shares by the current share price in order to determine a company’s weighting in the index.  As a result, many feel the market-cap based indexes are biased toward big, growth companies. The Fundamental-based funds determine a company’s weighting in the Index according to dividends and book value, thus giving them a more value-oriented approach.  ETFs, though not called index funds, are essentially index funds that trade like stocks.  Mutual fund index funds are priced once daily at the market close.  ETFs can be actively traded throughout the day.  The jury is out on performance when comparing market-cap and fundamental based indexes.  What is certain is that the expenses for the fundamental-based indexes are much higher, thus removing one of the main reasons to index; low cost.  All these products will be examined in detail, and you can determine which investment makes sense to you.

Asset Allocation

Asset Allocation is simply the percentage of your portfolio you choose to put in stocks, bonds and cash.  There is no correct allocation, as it is a very personal choice.  Your allocation parameters should be determined by your age, financial condition and risk tolerance.  We will offer several Model portfolios as well as options that may be substituted.  Many investment professionals feel that your asset allocation is as important, if not more important, than the actual investment vehicles you choose to invest in.

Actively-Managed Mutual Funds

Despite my strong inclination to make Index funds the foundation of your portfolio, there are still a handful of actively-managed funds out there which I would endorse as part of your core investment portfolio.  These are funds with long-term performance by Managers I greatly admire.  I will provide these funds and my reasons for liking them.

Cash

In the current precarious economic climate with rampant unemployment, putting aside six months to a year’s living expenses would be an astute plan.  But Certificates of Deposit tie up your cash when it might be needed.  Money Market funds, historically the parking place for extra cash, are currently paying such pathetic yields that this is virtually dead money.  But I have found a solid, safe alternative which is yielding nearly 4.0%.  I have all of my cash here, with a small amount in the Money Market fund for everyday expenses.

Individual and Speculative Stocks

It may surprise you to learn that I feel there is a place for these kinds of investments.  Individual and speculative stocks perform an important function in that they keep you interested and involved.  They can be a lot of fun, and sometimes quite profitable.  My feeling is that these securities should be held in a separate account at a discount brokerage, and funded with cash you can afford to lose.  This serves to create both a psychological and physical separation from your core foundation portfolio.  The two should never be confused

 

 

 

About William Judson

I have worked in the Asset Management arena for twenty years with JP Morgan Chase, Bear Stearns and Credit Suisse  Let me emphasize upfront that the only money I have ever managed is my own. But I have significantly outperformed the major indexes in my own portfolio for many years, as well as many of the portfolio managers I have supported.  It is only fair to note that I had none of the restrictions that portfolio managers have to operate under. I could change my asset allocation at will, as circumstances dictated. They could not. I was downsized from Bear Stearns after their acquisition by JP Morgan Chase, and I lost access to my portfolio performance for quite some time due to a “blackout” period.  2008 was a terrible year, as bonds got hammered along with cash.  But for 2007, my portfolio returned 15.75% to 3.53% for the S&P.  In 2006, my portfolio returned 6.50%, lagging the S%P return of 13.62%.  In 2005, my portfolio returned 10.46% compared to a 3.00% return in the S&P.  In 2004, my portfolio returned 26.72% compared to 8.99% for the S&P.  In 2003, my portfolio returned 40.33% compared to 26.38% for the S&P.  Again, it must be noted that my portfolio held stocks, bonds and cash every year, while the S%P 500 Index could hold only stocks.  But look at the returns, and judge for yourself.  I had superior returns, more diversification, lower risk, and still significantly outperformed.  My performance speaks for itself.

When I suggest an investment for your core portfolio, I will strive for plain vanilla, boring investments. In my investment world, boring is beautiful. I will seek to avoid leverage, swaps, shorting and most of the other more exotic investment vehicles.  I realize these are valuable investment tools for many people in the market. They are just not for me. When occasionally one of my suggestions deviates from this objective, I will duly note that fact.  Finally, I will seek to find the lowest possible expenses and fees for the best mutual funds so the investor keeps more of his investment.  I believe we will emerge from this dark financial tunnel, although the time frame is anybody’s guess.  But when this emergence occurs, there will be investment opportunities that we may never encounter again in our lifetimes.  Indeed, there are some fantastic opportunities out there right now.  Further, I believe the intelligent investor can flourish the old-fashioned way, namely by investing in stocks of fundamentally sound companies at discounted prices and in investment-grade bonds.  I’m putting cash to work today, as turmoil always creates opportunities for the educated investor.  So should you.

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