Exploding the Wall Street Myths
Shrewd operators (like many financial institutions) often take these myths and use them for their own ends. The inducements are familiar—potential tax savings, greater returns, less effort (and more!). Often, influenced by these myths, many people keep investing in the stock market regardless of the risks or cost to themselves.
Consider some of these present day sayings that have been repeated so often that they are widely accepted as truth.
Myth # 1
However when we examine these men’s histories, a different picture emerges. Peter Lynch, when establishing his record as a leading mutual fund manager, held stocks less than one year on average. (Source, Morningstar Principia). This is hardly “buy and hold.” In fact, Lynch’s average holding period for a stock was less than 8 months, and in one year less than 4 months. Yet his investment ads appear to espouse buy-and-hold. Something is not right with this picture.
Sir John Templeton, a legendary value investor, has a flagship quote, “buy a good bargain and hold it until you find a better bargain”. Not exactly buy and hold–period. Sir John also said, “All things cycle in and out of favor; investments and investment styles”, implying one needs to be ready to change with the markets.
Warren Buffet is widely proclaimed the king of buy-and-hold by the media. However, when I first did some research on this subject, I found that he regularly moved in and out of big holdings such as US Air, McDonalds, Silver and zero coupon bonds. It is reported that he actually sold most of his stocks in 1969 because he didn’t see any value in the market, and gave the cash back to investors and sat out of the market for several years. Buffet has sold many large holdings. Sold off—not held.These legends made their fortunes by being flexible
and adapting to changing markets.
The facts are, that from 1950 through 2006, the S&P 500 Index* went up 50.68% of the days the markets were open. The truth is that buy and hold works, but only about half of the time. Successful investors know this, and have a system for selling as well as for buying.
Invest for the long haul and you won’t be disappointed. This worked from 1983-1999, a period that just happened to be the strongest stock market ever. However, from 1966 through 1982, one might have had different results.
The Dow Jones Industrial Average* first hit 1,000 in 1966, then again in 1972, 1976 and 1981, retreating each time. The DJIA did not go above 1,000 for good until 1982, 16 years after the first time. Can you stand 16 years of struggling just to break even? Can you afford to? Most folks cannot. If you are one of them, then you need to become flexible and adapt to changing markets.
The real truth is that over the past 200 years of stock market history, there have been 7 different cycles where investors spent an average of 14 years struggling to break even. These periods are not unique.
History refers to these as generational bear markets because they take so long to complete. I call them generational because they can wipe out a whole generation of unprepared investors. Market action since the year 2000 suggests that we may have entered another generational bear market. As an investor, you need a way to deal with this. If you don’t have a way to defend your portfolio values, you could become part of another lost generation.
Myth # 3
This myth was spawned from a famous study done for the pension fund industry (Brinson, Beebower and Hood, Financial Analysts Journal, 1986). Wall Street took this study and proclaimed all you had to do was diversify among all of their different mutual funds and never fiddle with it, just leave it there for them to “manage” for you. Of course, Wall Street institutions need your money to make their money, so the last thing they are going to want is for you to take your money out of their accounts and put it in the bank.
For years, every mutual fund company representative that called on my business told their version of this study. I began asking the reps if they actually read the study themselves, and after a lot of hemming and hawing it was always “no”. So I finally got a copy of the study and read it myself.
What the Brinson study really says that 92% of returns come from the asset classes one invests in. This means 92% of losses as well as 92% of gains. The study does not say that diversification, or fixed asset allocation as it is called, eliminates the possibility of significant losses. It says if you are in the right investment classes you will do very well, but if you are in the wrong ones you will do poorly.
Diversification is a good start, making sure that all of your money is not in the investments going down, but there is a better way. Simply move more money into asset classes going up and have less in asset classes going down, and get the 92% factor in your favor. You’ll do better, but Wall Street might not like it.
Myth # 4
Perhaps, but bounces must be much higher than the prior drops. Consider the investor who experiences a loss of 50%, from $100,000 to $50,000. To get back to even, he must make a 100% gain, from $50,000 to $100,000.
Investments that double in value quickly are rare. How many years of investing will it take just to get back to even? To become a successful investor, avoiding large losses is often more important than making large gains.
Furthermore, markets or stock indexes may bounce back, and yet leave individual investments behind. During the 1990’s, 11 of the 30 stocks in Dow Jones Industrial Average were replaced with then current favorites. An index that drops laggards like Navistar, Bethlehem Steel and Woolworths and picks Microsoft, Home Depot and Wal-Mart could be expected to bounce a little better after the change. But if you owned Bethlehem Steel stock, rather than bouncing, your investments would end up on the dust bin of history.
In fact, many tech investments of the late 1990’s are never coming back at all. And many NASDAQ Index investors may not get back to even during their lifetimes, after taking a 78% loss from 2000-02.
The Solution:
August 16, 2007
(* The DJIA and S&P 500 are unmanaged indexes of stocks. Investments cannot be made directly into an index. Past performance does not guarantee future results.)
Will Hepburn is a private investment manager who specializes in active investment strategies. He is President of Hepburn Capital Management, LLC, a Registered Investment Advisor. He may be reached by emailing Will@HepburnCapital.com, or by calling (800) 778-4610, by writing to 805 Whipple St., Suite C in Prescott, AZ 86301, or by visiting our web site at www.HepburnCapital.com. Securities offered through Cambridge Investment Research, Inc. Member NASD/SIPC. Hepburn Capital and Cambridge are not affiliated.
The returns provided above are historical and shown for purely illustrative purposes. The S&P 500 is an unmanaged index and individuals cannot invest directly in the index. No consideration is made of costs that would have been incurred to actively managed a portfolio of S&P 500 stocks. Past performance is not a guarantee of future returns.
Copyright 2007. Permission to copy granted when attribution is included.
