The high cost of buy & hold

I recently had a conversation with a couple of investors who were currently dealing with big-bank brokerages. Coming from that background myself, I wasn’t surprised when these investors noted that their Advisors criticized the active trading approach to investing. Their logic behind the buy and hold “strategy” was that:

  • You can’t time the market
  • You want to avoid the tax consequences of realizing gains on an ongoing basis by holding rather than trading stocks
  • Good stocks rise over time. If you hold on long enough, these stocks recover from losses

 

Argument #1: You can’t time the market
I probably don’t need to harp on the first point to readers of this blog. Those of us who understand what true “market timing” means, understand the concept of buying and selling based on specific trend analysis tools.  More on this topic here.

 

Argument #2: Trading causes a tax burden
Let’s say you could find a group of stocks that you could be pretty sure will go up forever (this is a pretty bold statement to make—more on this below!!!). Great. So let’s say they go up at the same pace as a trading orientated portfolio does–lets suggest 10% per annum  to pick a number.

This miracle stock collection goes up 10%/yr. for 10 years. To keep things simple–given no compounding of returns–your $1MM turns into $2MM.

You now have a $1MM gain. At some point, you will want to take money out – or you may choose to leave it in your will – in which case your estate will be faced with a gain. That’s going to be quite a tax bill.

The tax burden on the large gain ($1MM gain after 10 years) will be at a higher rate than had you realized each years smaller gain through an active approach.  For example – lets say you make the the same $1MM over 10 years, but each year you realize  $100k by selling some stocks. At 50% inclusive (current tax policy in Canada taxes only half of your realized capital gains on individual portfolios) this works out to be $50k/year taxable income. If your taxable income isn’t too high, you will likely remain in a lower tax bracket than had you realized the much larger lump sum $1MM gain at the end of the 10 years.

It doesn’t matter how much you take out after your portfolio has captured such a large capital gain–you now have $1MM in gain to pay tax on at some point- or your estate will. That which you don’t pull out will keep growing and increasing your future tax burden (assuming the stocks go up forever).

Again though–the chances of finding stocks that always go up without 5, 10, 15 or more years of underperformance is thin, as discussed next.

 

Argument #3: They’ll come back!

Most investments need to be sold at some point.  If they don’t get sold at the right time, you lose money and/ or spend many years waiting to recover. Buy and hold does not work as people think. For example, here are some high quality stocks that many investors might think are ideal buy & hold stocks:

General Electric Company  is still down from its 1999 high (16 years!)-that must be frustrating!

GE

Microsoft  was below its 1999 high until last year–it was a 16 year wait for those investors to break even! A long time to just make a 3% dividend.

msft

Coca cola peaked in 1998–and spent 15 years (until 2013) falling and then trying to recover. A 3% dividend is all you made for that long lifetime of waiting!

ko

Canadian blue chips like Manulife–still below its 2008 highs (8 years under water).

mfc

BCE stayed flat from 2000 to 2011–that was 11 years of waiting before it became profitable – beyond the dividend.

bce

Former stalwarts like Bombardier peaked 16 years ago and is still falling. Nortel, Stelco and Teck were blue chip buy and hold stocks at one time. Need I mention Lehman Brothers, etc.?

BBD

Why lose money or make nothing just to avoid some tax? Pay the tax and take a profit–or watch the stock fall – lose capital or make little or nothing for years.
Instead of waiting,  you could have taken the high profit on any of the above stocks after they rose in price, and moved it into another stock with better forward potential after they began rounding over.  This allows you to earn greater and more immediate returns – rather than waiting for 5, 10, 20 years just to recover.

 

 

The information contained in this report is for illustration purposes only and was obtained from sources that we believe to be reliable however, we cannot represent that is accurate or complete. The portfolio may invest in leveraged or inverse exchange traded funds and thus there may be exposure to aggressive techniques which may magnify gains and losses and can result in greater volatility and be subject to aggressive investment risk and price volatility risk. All performance data represents past performance and is not necessarily indicative of future performance. Worldsource Securities liability shall only be attached to the accuracy of information contained in your official statement of account and information in your official statement of account will always take precedence over the information contained in this illustration. The figures are based on the portfolio holdings of Portfolio Manager Keith Richard’s account in the equity portfolio since June 30, 2009 and is gross of any fees and assumes re-investment of all distributions with no cash outflows or inflows. Values in percentage are annualized for periods of more than 12 months.

 

21 Comments

  • Hi Keith,

    When would be a good time to start buying into the Canadian Banks or ZEB.

    Thanks
    John

    Reply
  • Do you think that the S&P will hit resistance at 2040? It seems to me that much to the market moves are correlated to the movement of the yen, I have noted that just before options expiration there is a treasury buy date which seems to have a negative inpact on prices. The yen seems to move at the same time.

    Reply
    • Yes Bert–option expiry dates usually proceed a downdraft over the following week for up to a few days -even in good markets. I don’t know of the Yen relationship–but I do know that added to this type of pattern after options expiry is a potential for a seasonal selloff in that last week or two weeks of October-if not very extreme-so despite my currently buying stocks based on the signals I got last week–I am still holding some cash to see how things finish this month.

      Reply
      • In the days preceding and including the Aug,24 downdraft the value of the yes spiked. I noted a spike Friday after the bad jobs report. The yen fell during the day and the market rose. The Fed put 62 billion in to market Thursday and probably Friday. On the 15, the day before option expiry, the Fed is buying 26 billion in treasury bills. So we will see what happens around that time frame.

        Reply
  • Hi Keith- Saw you on Market Call last week. You stated that if Thursday was good then you might start buying. Thursday was down a bit but we have had good gains Friday and Monday. Is it time to slowly start taking positions?

    Reply
    • We held 52% cash until Friday. As the market turned in early afternoon that Friday, we invested 15%. Then we invested a further 15% on Monday morning (today). We are down to 22% cash as I write. There will be some pullbacks coming–we expect to spend the balance before month – end.
      That should answer your question!

      Reply
  • I just don’t see how people say you can’t time the market. Using seasonality alone will put you ahead of the index. Combining that with technical analysis is even more powerful. How can a blanket statement like that be made in the media, while they show no proof of it and yet everyone believes them. I guess that truly is “dumb money”.

    Eric

    Reply
    • Hey Eric–I’ve been fighting this for a long, long time!
      What I can say is that there is a vested interest by the investment industry in convincing people you cant time the market and should stay fully invested. Many reasons–first, a fund company doesn’t want you to sell their fund and lose the fees if you sell. Next, its true that MOST investors, and their “Advisors” CAN’T time the market-or don’t want to learn how and get involved with having to make those decisions-so they say it cant be done to sidestep the competition who do have the knowledge and tools to time things. Finally–and this is a big one–the biggest managers propagate this because, quite frankly–they actually CAN’T move in and out of the market due to their size. At VT–we only manage $125MM at this time–pretty easy to vacate stocks quickly (we typically hold 20 stocks when fully invested so each position is only a few million). So when we sold in April, it was done in a few days very easily. Contrast a manager with $3 billion $!!! Try selling your 3% position in ABC stock–that’s $90,000,000 in one position! You will flood the market. Try doing that over dozens of stocks. It cant be done very easily. So instead of confessing that truth, they tell you that “market timing doesn’t work”.
      BTW–market timing is like weather forecasting–despite the fact that sometimes they are wrong, you will notice that your favorite weather service is right 90-95% of the time. They use a series of analytics that allow them to be predictive with good accuracy–although not with infallibility. So do market timers. Its all about probability studies–and that’s why it makes sense. Better to trade with the odds vs. “hold n’ hope”.

      Reply
  • Hi Keith – For having been a client of firms promoting ‘buy and hold’, I think it is simply one way for the advisor to spend more time prospecting for new clients versus spending time with existing ones. It’s a business after all, and an efficient model for the advisor.

    Reply
  • Hi Keith:
    Time will prove your point over and over again. However, I don’t think you will make too many converts in the investment business. Your recent articles will surely demonstrate to your clients and those prospective your solid methodology and transparency. Great stuff.

    Khokon Guha

    Reply
    • Thanks Khokon
      I have good friends in the business who think like me–guys like Brooke Thackray, Don Vialoux, Hap Sneddon, etc.
      But you are right about the BBB’s (big bank brokers) and “Financial Planning” fund salespersons–they don’t much care for this message.
      When I worked for Merrill Lynch years ago – I wrote an article showing the poor performance of managed products/mutual funds- and criticized their buy/hold concepts–the head of regional sales at Merrill (and another one at a subsequent bank firm I worked at) told me I wasn’t allowed to deliver such messages to the investing public, given the fact that most of their sales force (except me) was buying those very products for their clients. One head office guy at a big firm I worked at actually emailed and told me to “cease and desist” on delivering this message after he read something I wrote in a magazine. I wish I had printed that email and framed it!
      The censorship was one of the many drivers that forced me to go independent!

      Reply
  • Hi Keith:
    Your results amply demonstrate your investment services your clients will receive. By the way, i have huge respect Don Vialoux and others noted above. My interest in technical analysis was due to not the likes of John Murphy, not to detract anything from their books and accomplishments but your books because of the simplicity (Smart Bounce) and Don’s blog Timing the Market.

    Hey Thank you.

    Reply
  • Keith, great article and info. I’m fairly new to technical analysis but find myself learning more from the examples and teachings you provide. My question is related to the examples you listed above, were said companies trading at lofty valuations from a fundamental stand point at the point in which they began to descend and if so would a value analysis at those times have painted a red flag? Thanks.

    Reply
    • Not being a fundamental guy, I cant comment too much- except to note that the PE trailing ration for S&P500 was near the top end of its “normal” range–not overvalued but not cheap. Also the Shiller PE was and still is high – but its a leading indicator with a big leading window.
      We do fundamentals via my associate Craig Aucoin – he filters my technical picks to ensure we only own quality.

      Reply
      • Thanks for the clarification Keith. It would seem the combination of technical analysis and fundamentals is the magic formula. In the past i’ve never put too much credence in technicals but as time has gone on i’ve seen it’s workings and the factor it plays in markets. Thanks for all the knowledge sharing you do on this site and on BNN. Much appreciated.

        Reply
  • Great article. There is a lot of great info here. I am rather new to the world of investing so it is nice to read an article with honest information. I know a lot of successful people who are fans of buy and hold so it was interesting to read this. Thanks for sharing.

    Reply
  • Keith, I would like to use MFC above as an example of asking what is the best way to have a long term look at a stock’s price chart. You showed MFC on an adjusted basis for any splits/stock dividends as well as the impact of dividends earned. Currently, MFC at about $27 is now only $4 or so off its 2007 high of about $31 and is in an upward trend.

    However, on an unadjusted basis (_MFC), the 2007 high is approximately $44 so the price has even further to go to exceed its prior high (post 2006 split from a high of $75) and even much further to exceed the pre-split high.

    The unadjusted chart reflects what we look at when it is necessary to prepare a tax return as it provides, in part, a relation to the adjusted cost basis as well as just the resulting price gain or loss. The adjusted chart though seems to impart some measure of total return.

    The unadjusted chart in addition provides a means to view the overall price strength of a company. Consider RY as an example that has gone through two 2:1 splits since the early 90’s and each time the stock price has, over time, exceeded its pre-split high and if history were to repeat should be readying for another split. On an adjusted basis, you would not discern this.

    I would welcome your thoughts on this.

    Reply
    • David–you bring up a great point – the adjusted charts are best used with lower dividend stocks. The adjusted charts such as those used on stockcharts.com prefixed with the underscore (as you note) are actually a better way of reviewing the stock if it pays a high dividend. So doing this on the MFC chart would have better shown long term patterns.
      The reason we should use unadjusted price charts in higher div. stocks is that we, as technical analysts, are not looking especially at total return charts. We are looking for price points where crowd behavior has caused support/resistance points trendlines, etc etc. Those are price points that investors remember. We need to be aware of them – and they are better reflected with unadjusted charts. Thanks for pointing it out.

      Reply

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