The Great Recession of 2008-2009 saw many investors lose huge amounts of money. The average retirement portfolio took more than a 30% hit, and the modern portfolio theory (MPT) fell out of repute, seemingly debunked by a two-year period where buy-and-hold investors saw a decade of gains wiped out in a figurative instant. The massive sell-off during 2008-2009 seemed to violate the rules of the game; after all, passive investing was not supposed to absorb losses of that magnitude.
The reality is buy-and-hold still works, even for those who held passive portfolios in the Great Recession. There is statistical proof that a buy-and-hold strategy is a good long-term bet, and the data for this hold up going back for at least as long as investors have had mutual funds.
The Logic of Buy-and-Hold Investing
"Buy and hold" does not have a set definition, but the underlying logic of a buy-and-hold equity strategy is fairly straightforward. Equities are riskier investments, but over longer holding periods, an investor is more likely to realize consistently higher returns compared to other investments. In other words, the market goes up more often than it goes down, and compounding the returns during good times yields a higher overall return as long as the investment is given sufficient time to mature.
Raymond James published an 85-year history of the securities markets to study the hypothetical growth of a $1 investment between 1926 and 2010. It noted that inflation, as measured by the controversial consumer price index (CPI), eroded more than 90% of the dollar's value, so it took $12 in 2010 for the same purchasing power as $1 in 1926. Nevertheless, $1 applied to large-cap stocks in 1926 had a market value of $2,982 in 2010; the figure was $16,055 for small-cap stocks. The same $1 invested in government bonds would only be worth $93 in 2010; Treasury bills (T-bills) were even worse at a paltry $21.
The period between 1926 and 2010 includes the recession of 1926-1927; the Great Depression; subsequent recessions in 1949, 1953, 1958, 1960, 1973-75, 1981, and 1990; the dot-com crisis; and the Great Recession. Despite a laundry list of periods of turmoil, the markets returned a compound annual growth of 9.9% for large caps and 12.1% for small caps.
Volatility and Selling Into Falling Markets
It is just as important for a long-term investor to survive bear markets as it is to capitalize on bull markets. Take the case of IBM, which lost nearly one-fifth, at 19%, of its market value between May 2008 and May 2009. But consider that the Dow fell by more than one-third, at 36%, over the same period, which means IBM shareholders did not have to recover nearly as much to see the precrash value. Reduced volatility is a major source of strength over time.
The principle is evident if you compare the Dow and IBM between May 2008 and September 2011, when markets were starting to take off again. IBM was up 38%, and the Dow was still down 12%. Compound this kind of return over multiple decades and the difference could be exponential. This is why most buy-and-hold advocates flock to blue-chip stocks.
IBM shareholders would have made a mistake by selling during 2008 or 2009. Lots of companies saw market values disappear during the Great Recession and never recovered, but IBM is a blue-chip for a reason; the firm has decades of strong management and profitability.
Suppose an investor bought $500 worth of IBM stock in January 2007 when share prices were approximately $100 a share. If he panicked and sold in the depth of the market crash in November 2008, he would have only received $374.40, a capital loss of more than 25%. Now suppose he held on throughout the crash; IBM crossed the $200 a share threshold in early March 2012 just five years later, and he would have doubled his investment.
Low Volatility vs. High Volatility
One 2013 Harvard Business School study looked at the returns a hypothetical investor in 1968 would have realized by investing $1 in 20% of U.S. stocks with the lowest volatility. The study compared these results with a different hypothetical investor in 1968, who invested $1 in 20% of U.S. stocks with the highest volatility. The low-volatility investor saw his $1 grow to $81.66 while the high-volatility investor saw his $1 grow to $9.76. This result was named the "low-risk anomaly" because it supposedly refuted the widely cited equity-risk premium.
The results should not be all that surprising, however. Highly volatile stocks turn over more frequently than low-volatility stocks, and highly volatile stocks are less likely to follow the overall trend of the broad market, with more bull years than bear years. So while it might be true that a high-risk stock is going to offer a higher return than a low-risk stock at any single point in time, it is much more likely a high-risk stock does not survive a 20-year period compared to a low-risk stock.
This is why blue chips are a favorite of buy-and-hold investors. Blue-chip stocks are very likely to survive long enough for the law of averages to play out in their favor. For example, there is very little reason to believe The Coca-Cola Company or Johnson & Johnson, Inc. will be out of business by 2030. These kinds of companies usually survive major downturns and see their share prices rebound.
Suppose an investor purchased Coca-Cola stock in January 1990 and held it until January 2015. During this 26-year period, she would have experienced the 1990-91 recession and a full four-year slide in Coca-Cola stock from 1998 through 2002. She would have experienced the Great Recession as well. Yet, by the end of that period, her total investment would have grown 221.68%.
If she had instead invested in Johnson & Johnson stock over the same period, her investment would have grown 619.62%. Similar examples can be shown with other favorite buy-and-hold stocks, such as Google, Inc., Apple, Inc., JPMorgan Chase & Co., Nike, Inc., Bank of America Corp, Visa, Inc., and Sherwin-Williams Company. Each of these investments has experienced difficult times, but those are only chapters in the buy-and-hold book. The real lesson is that a buy-and-hold strategy reflects the long-term law of averages; it is a statistical bet on the historical trend of markets.
As a seasoned financial expert with a deep understanding of investment strategies and market dynamics, I want to shed light on the comprehensive concepts discussed in the article about the effectiveness of buy-and-hold investing, especially in the context of the Great Recession of 2008-2009.
First and foremost, the article touches upon the aftermath of the Great Recession, emphasizing the significant losses many investors faced during that period. The average retirement portfolio suffered a more than 30% hit, challenging the credibility of the modern portfolio theory (MPT) which had been widely followed. This was a transformative moment in financial history where even long-standing strategies like buy-and-hold were questioned.
However, the key argument presented in the article is that buy-and-hold investing still proves to be a viable strategy, even for those who weathered the storm of the Great Recession. The article backs this claim with statistical evidence, asserting that a buy-and-hold strategy has historically demonstrated success over the long term.
The logic behind buy-and-hold investing revolves around the idea that, despite the inherent risks in equities, holding onto investments over extended periods tends to yield consistently higher returns compared to other strategies. The article cites Raymond James' 85-year history of the securities markets, showing the hypothetical growth of a $1 investment between 1926 and 2010. Despite periods of economic turmoil, the markets returned compound annual growth rates of 9.9% for large-cap stocks and 12.1% for small-cap stocks during that time frame.
The article also delves into the importance of surviving bear markets, highlighting the case of IBM during the 2008-2009 market downturn. The principle emphasized is that reduced volatility can be a strength over time. Comparing the performance of IBM and the Dow between 2008 and 2011, the article illustrates the potential exponential difference in returns for long-term buy-and-hold investors, particularly when dealing with blue-chip stocks known for their stability and resilience.
Furthermore, the article introduces the concept of volatility and its impact on investment returns. A 2013 Harvard Business School study is mentioned, demonstrating the "low-risk anomaly." This anomaly challenges the widely cited equity-risk premium by showing that low-volatility stocks outperformed high-volatility stocks over the long term. The study suggests that, while high-risk stocks may offer higher returns at specific points in time, they are less likely to survive over extended periods compared to low-risk stocks.
The final segment of the article emphasizes the significance of blue-chip stocks in the buy-and-hold strategy. These stocks, exemplified by companies like Coca-Cola and Johnson & Johnson, are considered likely to survive major downturns and rebound over time. The article provides examples of successful buy-and-hold investments in well-known companies like Coca-Cola, Johnson & Johnson, Google, Apple, JPMorgan Chase, Nike, Bank of America, Visa, and Sherwin-Williams, illustrating how enduring through difficult times can lead to substantial long-term returns.
In summary, the article makes a compelling case for the continued relevance of buy-and-hold investing, showcasing historical data, real-world examples, and academic studies to support the argument. It underscores the importance of understanding market dynamics, volatility, and the resilience of certain stocks in building a successful long-term investment strategy.
