Question From A Reader
A reader has asked me to comment specifically on an article that recently appeared in The Globe and Mail titled, ‘With funds, buy and hold doesn’t always pay off’ written by Mr. Rob Carrick. You’ll probably need to read the article to put my answers in context. (I don’t really have anything negative to say about it, but if you read through the comments at the bottom of the Globe article there are some readers of the Globe who took issue with it.) Specifically, the reader mentioned that her advisor always touts the buy and hold philosophy and she was beginning to question the blind practice of this strategy.
The Quick Answer
Long answer short: buy and hold is the way to go, so long as you are in the right investments and understand the ride you can and should expect when investing in equities. Trying to time the market, or constantly switching between strategies or investments more often than not produces sub-standard results.
Food For Thought
One of the questions posed by the author was to ask if readers thought 5 years or even 10 years was a good, long time to hold a fund (in order to reap the benefits of equity investing). He then goes on to show some funds that have had poor performance during this time. This is actually quite good from an educational perspective: consider a post that I wrote earlier which indicated that some academics indicate that you may need 30 years before you can say with statistical confidence that stocks will outperform T-bills. And in actual historic performance, T-bills outperformed US stocks for 17 years from 1964 to 1981. If you are going to invest in equities, you need to be prepared for years of negative performance (perhaps even decades although this would be extremely, extremely rare). Given that even the largest stock market in the world (the US) can have years of negative performance, it is worth looking into diversifying into other markets. Of course, staying the course is really a matter of easier said than done!
Since this article is dealing with actively managed funds, then there is an extra variable to consider: relative performance of the manager versus the peer group and the index. In the context of the article, you certainly need to pay attention to the manager’s relative performance. It’s a given that equities can have long periods of negative performance, but periods of relative underperformance (even if the absolute performance is positive) is an investing sin – but can also occur over short periods of time. I’m not much of an ajudicator of active funds, I gave that up a while ago, but the logic that a longer leeway should be afforded to managers with longer track records seems prudent. Even Warren Buffett can underperform his benchmark during short timeframes.
I suppose there is one minor point to which I might offer up an alternative approach. Mr. Carrick suggests that with newer managers, it would be best to let them demonstrate good performance for a while before investing your money with them (in the hopes of benefitting from their good performance after they have established themselves as being worthy). An alternative would be to just stay away from them altogether since research has shown that newer, unidentified managers who provide good performance will eventually lose this ability as more and more money is given to them. One way of thinking about this is that if a manager has $50 million dollars worth of good ideas per year then they look great when they are managing $50 million dollars. But as the fund grows organically and then from money invested by new investors, perhaps the fund is now worth $500 million. $50 million of good ideas and $450 million worth of less than good ideas doesn’t seem so attractive.
In the end, if you are investing in actively managed funds I think the article raises good points. If you are still unsure about your advisor’s recommendations, it never hurts to get a second opinion (or a third). If you would like to subscribe to Rob Carrick’s RSS feed you can click here for the feed details.