A Better Way than “Buy and Hold”
In the late 1950s, John Bogle changed the investing world.
Bogle became the chief advocate for index investing, a strategy based around the idea that investors should stop trying to pick individual stocks, quit buying mutual funds, and just buy the big stock indexes.
Why would an investor take such a hands-off approach? Bogle cited research that proved that most actively managed mutual funds don’t beat the market – and on top of that, they charged hefty management fees for their mediocre performance. The data was damning, and Bogle’s fund, the Vanguard 500 Fund, became one of the most popular investment funds in history, today worth more than $26 billion.
The Vanguard 500 fund doesn’t pick stocks. Its managers don’t have opinions on which indexes are best. It just tries to mirror the S&P 500 Index as closely as possible. And it does it for a tiny management fee.
Today, there are scores of index funds and ETFs that mirror all sorts of different market indices. If you want to buy “the market” or “stocks in general,” just plow some cash into one of the funds. Passive, hands-off investing has become the norm for scores of investors in the last five decades, becoming the “buy and hold” strategy that most people know about. Today, I want to bust some myths about everyone’s favorite way to invest…
So, if passive index investing is so great, why would you ever want to pick a stock again? Well, it’s because the hands-off buy and hold approach isn’t so great after all.
For starters, there’s no such thing as a “buy and hold forever” approach (no matter what certain octogenarian billionaires in Omaha may claim). That’s because everyone who’s ever tried it is broke.
Even though everyone in the industry calls index investing “passive,” there’s really nothing passive about it. The Dow, the S&P, the Russell – they’re all active investment strategies. Don’t follow?
Of all of the stocks that were part of the original Dow Jones Industrial Average, only General Electric is still a part of the index. All told, the index has changed 48 times since it was created – all of those changes being picked by the editors of the Wall Street Journal. That means that the Dow is in fact an active stock-picking index.
It’s how they unloaded garbage names like Kodak, Chrysler, and Woolworth when they hit the skids…
The S&P 500 is no different. S&P components are picked by a committee at Standard & Poors, who try to make the index mirror the 500 biggest stocks on the market. Since the rules on who makes it into the S&P 500 are largely based on who’s the biggest, stocks that fall get tossed out, and stocks that increase in value get added. So, in other words, the S&P committee is selling the losers and buying the winners. It’s the very reason why Apple (NASDAQ:AAPL) is a bigger chunk of the S&P 500 now, and Enron isn’t. We’ll get back to that in a minute.
The bottom line is this: passive investing doesn’t spare investors from the risks of stock picking. It just takes the stock picking off of portfolio managers’ plates and leaves it up to Dow and S&P.
Clearly, that hasn’t worked very well lately either. In the last 12 years, for example, the S&P 500 has actually lost just over 2%. So much for “buy and hold” always working out in the long-term.
A Different Way to Invest
But there is a different way to invest – a better way…
The key is in that phrase I mentioned from the S&P: selling losers and buying winners. It’s ironic, but the most successful long-term strategy any fundamental investor can point out is in essence a technical approach known as “trend following”.
The main idea behind trend following is simple: the market moves in big, long-term trends, and if you can identify them, you can ride them. It’s an approach that some of the most successful investors in history have used — and one you can use too.
Trend following can also avoid the pitfalls that index investors have struggled with over the past few years. You see, the S&P’s approach to trend following is crude at best. Since correlations between stocks in the S&P are very high, it’s not as effective at reducing risk as it could be. That’s why a purpose-build trend following approach makes so much more sense than all of this buy-and-hold brouhaha.
Over the next few weeks, I’ll be sharing more details about this strategy in future Trend Playbook issues. I’ll be pulling back the curtain, showing ways of identifying trends that point to the biggest profits, and telling you exactly which trends are heating up right now…
[Editor’s Note: If you haven’t already, you can sign- up for Trend Playbook right here. Trend Playbook is a FREE e-letter designed to give you the tools and teach you the strategies to continually pull consistent gains out of any market.
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Stay tuned and happy trading,
Jonas Elmerraji, CMT
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