Roughly 40,000 of Warren Buffett’s cult-like army of devotees will descend on Omaha for Berkshire Hathaway’s annual shareholder meeting. USA TODAY
As he’s done at virtually every other Berkshire Hathaway meeting over the last five decades, CEO Warren Buffett argued at the company’s annual gathering this month that investors should buy and hold a stock index fund for the long term.
What has changed over the years, however, is investors’ receptivity to Buffett’s approach, which calls for holding onto stocks through thick and thin regardless of ups-and-downs in the market.
Investors recently have been far more willing to believe him than they were at the depths of the financial crisis a decade ago, for example.
The reasons for this shift are a cautionary tale showing why you shouldn’t let your emotions rule your portfolio.
That’s because your fears and hopes will almost certainly lead you in the wrong direction.
You are likely, for instance, to abandon buying and holding just when you should be more committed than ever. That time is at the bottom of a bear market — just as a new bull market is about to begin. But guess what? Since market bottoms are when the stock market is sitting on the biggest losses, that’s when buying and holding is the least popular.
On the other hand, you’ll likely be tempted to embrace buying and holding at the worst possible time — when the market is lofty and headed for a fall. It’s at the end of long bull markets that buying and holding is most popular.
Just the opposite is true for a market timing approach, which calls for going in and out of stocks and other investments based on factors like Wall Street trading patterns and economic signals. The best time to become a market timer is at a top, as a new bear market is about to begin.
That’s not because market timers are more competent during bear markets, but because any time they move out of stocks and into cash during declines, they’ll gain ground on buying and holding — even if those times out of the market are picked by a market timer who has no ability.
In the 2007-2009 bear market, for example, the average stock shed nearly 60% of its value. Other than Mr. Buffett, true believers in buying and holding were few and far between at the March 2009 bottom. Indeed, a widely-expressed view among the investment newsletter editors I monitor was that “buy and hold” was dead.
Today, by contrast, with the Standard & Poor’s 500 index more than four times higher than where it stood at that bottom, we are at the opposite extreme. Most of the buy-and-hold skeptics have become converts to the approach. Now it’s market timing whose usefulness is being questioned.
Note carefully that investors’ shifting opinions towards buying and holding, and market timing have nothing to do with their statistical merits. As Mr. Buffett often notes, hardly any market timers are able to do better than an index fund over the very long term. He’s right, of course.
As you ponder whether to follow his advice, however, the question before you is not statistical as much as it is psychological. Are you willing to remain a buy-and-hold investor through the next bear market?
There’s no shame in admitting that you don’t have the stomach for those big losses. What you don’t want to do is to discover, at the bottom of the next bear market, that you don’t have what it takes.
Far better to sell some stocks and start building up cash in your portfolio now, with the market at relatively high levels. Even if you don’t catch the exact top — and it’s unlikely that you will — you still will be far better off than throwing in the towel at the bottom of the next bear.
Only if you have the rare intestinal fortitude required to truly stick with an index fund through a severe bear market should you now be taking Buffett’s advice to buy and hold.
Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers’ performances for four decades. For more information, email him at email@example.com or go to www.hulbertratings.com.
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