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Why Buy and Hold Makes Sense, at Least for Some of Your Investments

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Plus: Where to look for outperformance.

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The global economic outlook has gotten murkier; no longer does the outlook appear assuredly sanguine. The premise that the US has had its recession and that now the economy and the markets will advance seems to be not so certain. Bearish sentiment has risen and inflows into broad market ETFs have lessened. An investor has to make a decision, as usual, as to whether or not to be in the market. History suggests that it is better to be in the market because to be out of the market is betting against the odds; over the last 100 years or so, the market has ultimately moved higher. And the thing is to be in the market every day, rather than just guessing trends on a short-term basis.

In my book Winning with ETF Strategies (FT Press, 2012), I showed the results of investing $1.00 in the S&P 500 Index (INDEXSP:.INX) in 1966 and what the return would be over a 40-year period in three different scenarios:
  • If you had been out of the market on the best five days each year;
  • If you had been out of the market on the worst five days each year; and
  • If you had simply held the index through the good and bad days of each year.
The buy and hold strategy would have returned $16.58, which is a decent amount. If you had missed the five best days each year, you would have had a very poor return, with only $.11 left on the invested dollar. But if you had missed the worst five days each year, you would have had a great performance, the $1.00 being worth $2,520.94.

There are also big differences in the performances of each year. For instance, 1987 was essentially a flat year. But if you had missed the five best days, you would have been down about 20% that year; if you had missed the five worst days, you would have been up about 60%. In 1975, the market was up over 31%, and without the best five days, an investor would be up only about 18%. Without being in the market on the five worst days, an investor would be up almost 46%.

Forecasting when to invest in the market on a daily basis is much more granular than forecasting on a trend basis because big gains and losses, which change portfolio performance drastically, can both come during one day. You can be right on a major market trend basis, and sell out all or part of your positions for a few days, and have your performance lag because of what happens on a daily basis.

One reason that this information should be considered when investing: If you are out of the market on the good days or some of the good days, your performance will suffer -- and no one knows when the good days or the bad days will be. So if you cannot consistently be in the market on the good days, or be out of the market on the bad days, then it is best to be long stocks for that amount of capital you can reasonably invest and want to invest. And if you are long, then you want to find the asset classes that have the best chance of performing.
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Max Isaacman holds AXJL at the time of this article's posting.
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