I tried to write a serious post on my recent experience of actively attempting to make myself believe in buy and hold investing, but realized I am a ridiculous person, so it’s only semi-serious as it’s an actual play-by-play of my thought processes.
Since this ended up turning into a few chapters of my weird future autobiography, I took the opportunity to weave in some basic investment concepts and present them forth in a (hopefully) not dry and boring way. I did this because whenever I ask my non-investing friends why they aren’t into it, they usually say it’s because a lot of the info out there is boring.
What do I mean by buy and hold?
Different people have different definitions of what buy and hold investing means to them. For simplicity, when I use the term, I’m referring to the broad concept of purchasing safe, stable securities, such as index tracking ETFs, blue chip stocks, or other established medium to large cap equities and holding them for the long term.
Assume a duration of +/-10-15 years (although Warren Buffet advises to choose only securities you intend to hold for life). The investments would be held through extreme volatility and market crashes under the assumption that over time, stocks and markets tend to rise and it’s better to ride everything out. This is in direct contrast with trying to beat and time the market, which is the concept of selecting securities and entering and exiting positions as a means of outperforming the S&P 500.
Why couldn’t I just be like everyone else?
Up until recently, I wanted so badly to be into “buy and hold” investing. It seemed that for much of the investment community, sticking with investments long-term, through thick and thin was the golden rule for success, but to me, it never made much sense.
I just couldn’t wrap my mind around why someone would willingly hold on to an investment that was clearly tanking and then proceed to continue riding it all the way down. The fact that someone would endure this pain, potentially losing half their assets, all because they didn’t believe they could “time the market” was beyond me.
I didn’t believe I myself could time the market, either, but I also didn’t believe in watching ~50%+ of my assets dissipate over a few days or weeks by refusing to get off a sinking ship.
What I did believe was predefining risk tolerance levels before entering into a position. If you couldn’t summon the foresight to define what you believed would occur, why were you even taking the position in the first place?
Thinking about the future and trying to determine a “what if” scenario for both good and bad price action takes mental effort. At the very least, setting a wide trailing stop loss to protect profits is easy enough.
It’s not you, it’s me
ting to my personality type, as I thought it was too boring. I like novel and interesting things and can get bored easily, so the idea of making an investment to hold through thick and thin for 5000+ years was about as exciting to me as getting socks for a Christmas gift was when I was five.
On the flip side, I also knew well the saying “if you want excitement, go to the casino, not on the stock market,” so when my business analyst consulting started taking up more of my time a few months ago, I decided it was finally time to grow up and officially be a buy-and-holder.
I decided I’d do an experiment over the next few weeks where I gave it an honest, unbiased go.
Since the whole premise of passive investing is not really doing anything at all, I ended up filling my time with a lot of thinking about this not doing anything passive strategy. It was a good exercise as I was forced to really ponder why I believed in active investing over passive. After a few weeks of mulling, I eventually came to the conclusion it wasn’t for me.
The set-it-and-forget-it style just didn't jive with the trading philosophies I’d developed over the years. Though I’m okay with no longer trying to fit a square peg into a round hole for the moment, I’m open minded and hope someone can convince me otherwise by dispelling my beliefs, which are laid out below in this riveting think piece.
Why am I like this?
After years of believing my views on active investing were wrong or flawed in some way and wondering why I had them, I realized they were shaped greatly by “growing up” in the era of electronic and algorithmic trading.
My first ever internship out of college was at a Boston based FX hedge fund that built and used trade replication technology. Right out of the gate, my ideas of how the market worked were purely systematic and I was never really exposed to much traditional investing.
A few years later, being at a quantitative managed ETF investment firm pushed me further into the realm of “the market is a very risky place, don’t turn your back on it for a second”.
The firm’s model would be allocated into various market sectors and when its algorithms detected volatility in any one, it would be dropped and the balance redistributed to the remaining sectors (or moved into gold and REITs if there was real market turbulence). The goal was to give investors exposure to market gains while protecting them from downside risk by quickly moving out of sectors once they started becoming dodgy, and back in once they chilled out.
After seeing past market crash decimation, to me, it was only natural to exit a position in times of uncertainty and get back in when the coast was clear. I wasn’t egotistical enough to believe I could forecast market moves, so I just played it safe. If I were ever unsure, I’d ask myself “would I enter this position now if I weren’t already in it?”.
Having a thorough understanding of the financial technology and algorithms making up the market’s infrastructure made it difficult to get on board with the views of traditional, buy and hold investors who were not intimately familiar with the technology. The market they once knew was no longer manned by human hands.
When trying to convey these things to them, I often felt really out there, like the crazy people you see screaming and yelling in the street about the end of the world.
However, I would always be empathetic and try to see their viewpoint anyway. But I knew deep down, I would always love trading technology first and foremost.
Risk management remained at the core of my beliefs
In terms of duration, I have always been most drawn to swing and shorter-term position trading, aiming to hold positions for weeks or months. I believe in the idea of cutting losses quickly and letting winners continue on, so if one were losing, the duration would obviously be shorter. As founder of Investor’s Business Daily William O’Neil advises, if you enter into a position and it ends up moving against you 7% to 8% below your purchase price, just admit you were wrong, cut the loss, and move on.
All big losses were small at one point.
I believe risk management is the most important part of investing and that means cutting losses quickly. I don’t know what the market is going to do, nor can I control it. What I can control is my risk by not bleeding out and thus, living to participate another day.
I’d always seen a dichotomy between the investment and trading worlds. It reminded me of the contrasting scenes in the movie Titanic that’d oscillate between the refined upper deck, first class passenger life vs. the lower deck chaos of rowdy bars and sweaty dudes shoveling coal into furnaces to keep the ship moving forward. I saw the traditional client facing wealth management world as the fancy, refined cigar parlor, and the trading floor as the crazy engine room.
I believe this came from the investment banker social group I fell into when I first moved to Boston. To my naïve, untrained eyes, they seemed so fancy and I was like “wow, these two sides of the same industry are so different”. I was in FX trading at the time, which I’d often hear referred to as the “wild west”. Some of the traders I worked with early on were such eccentric and hilarious characters.
I always found the engine room more interesting.
I liked the traders because many were wild and raucous and would say crazy things and do and wear whatever they wanted and not care because they were super smart. As long as they were making their firms a ton of money and staying legal, anything went. Obviously I felt more at ease with this cohort; I like people who don’t take themselves too seriously.
My brief foray into buy and hold land
Getting in the zone
I felt very mature now that for the first time in my life, I was feeling okay with putting my wild and crazy trading days behind me and getting my conservative investment life underway.
I love Warren Buffet quotes, so obviously I reread a bunch for inspo on how to be a normal investor and not a trading maniac. I found particular inspiration in:
I wasn’t exactly sure how this applied to investing, but I found it worked for many other facets of my life and I liked the mental imagery it evoked, so it quickly became my favorite.
In it for the long haul
Since I was now fully committed to doing long-term investing for real, I spent hours researching and designing three diversified portfolio allocation models of ascending complexity.
A starter one for right now - very safe and sensible, comprised mostly of index tracking ETFs, and a few sector ETFs (no fun here, guys).
One for a few years down the road, when I was that much smarter and wiser.
And a third more complex one for many years down the line when I was a rich genius that had some crazier stuff in it, to give me something to look forward to.
All three were built to be passive and with intention of being held for years.
One thing I learned while at the managed ETF quant shop was the many advantages of exchange traded funds (ETFs). They have built in diversification and generally carry less risk and volatility than an individual stock. Single stocks are vulnerable to many risks that can cause quicker and more severe swings, such as poor earnings, company scandals, or bad industry news. Not to mention, one company can go out of business, while companies in an ETF will likely be culled before they go defunct.
Since index ETFs are comprised of a basket of equities, their primary risk is systemic, or broader market risk. There are more focused versions of these investment vehicles, such as sector ETFs and many others, but any negative impacts of a few very volatile stocks within will be greatly diluted by the natural diversification inherent to the fund. This is less so the more focused the basket, such as TFMG Video Game Tech ETF (GAMR) or iPath Bloomberg Livestock Subindex Total Return ETN (COW). (Cow. lol)
ETFs that track indexes also have the advantage of passive management, meaning as the index scraps subpar equities, the fund automatically reflects the pruning.
Whenever people ask me what they should invest in, I always explain that unless they’re really into equities analysis and putting in the time and effort it takes to actively manage your own portfolio on a very regular basis, invest primarily in index or sector ETFs over single stocks to reduce risk. Check them diligently and learn some securities analysis basics, but with ETFs there will generally be less risk.
Pulling the trigger
I was finally ready to put in my equity ETF orders with long positions in Vanguard’s S&P 500 (VOO), State Street’s SPDR S&P 500 (SPY), and Invesco’s NASDAQ QQQ.
Oddly, just as I was about to place them, I got a wee bit trigger shy, finding I could not bring myself to put all of the originally intended orders through. This was primarily because the market was still moving sideways and had not yet picked a direction. Plus, I couldn’t relinquish all my previous trading rules at once… baby steps.
The S&P had recently broken out of its trading range on August 21, 2018 by surpassing its previous January 26, 2018 high of 2,872.87. I’d been waiting until this price was passed and held steadily at least a few weeks to know that for the moment, the bull trend had resumed. This was very exciting since I was sick of watching the market bounce around in a range for seven months like a never-ending game of ping pong (the real kind, not the one with beer). Very boring.
The thing about trading ranges is this: Since securities tend to trend with the market’s overall direction, it really helps when one has been established for picking the direction of your own positions. Trading with, not against, the current is usually your best bet.
I tried to stop thinking about this because I wanted to get away from my former chart scrutinizing and technical analysis obsession because why would I need any of that now since I was going to hold on to my index ETFs no matter what? So what if the chart was starting to look like the declining side of an Etch a Sketch Bob Ross mountain?
It didn’t. Because I was now committed to long-term buy and holding, even if that meant wiping out half my assets.
Either way, I couldn’t stop thinking about the price action because I have intrusive thoughts. So, although the price level had been hit when the S&P’s previous all time historical high had been broken, I still felt very unsure about the stability of an upward continuation. This was due mostly to near-term interest rate hikes, trade tariffs, the almost nine year bull market, and the aggressive rally that took place the past few years. I couldn't help but feel we were deep into a teetering Jenga nightmare and someone with an unsteady hand was about to pull next.
Even though I was fully committed to my long-term strategy, I decided to take smaller positions in the broader market ETFs just for the time being.
I don’t know what the market is going to do, but I know what it is doing right now, and if a security is trending down, I’m not going to stick around and play the how low can you go game.
I think the message on holding long-term is a bit scrambled and the risk isn’t so much about letting go during volatility, but rather, about getting out and not getting back in when the drop reverses. Yes there is risk of being whipsawed here, but if done strategically and not impulsively, this can usually be mitigated.
The beginning of the end
Theoretically I haven’t actually “ended” my buy and hold experiment as I still have small positions in the index ETFs so I can keep watching them long-term and laugh at myself when they beat me in a few years. Fun isn’t over yet.
I only relinquished my attempt at forcing myself to believe in buy and hold passive investing.
The straw that broke the camel’s back was actually one of the single stock positions I added into my beginner portfolio design.
I obviously had to do ONE speculative position, so I chose a pre-clinical biotech company called Unity Biotechnology (NASDAQ:UBX). I’d been following them for a while as I found their senolytic drugs targeting age related degeneration quite intriguing. The co-founder, scientist Nathaniel David, had also previously co-founded Kythera, a biotech company that sold to Allergan for $2.1 billion in 2015.
Unity is David’s sixth company, and as he explains, “you get kind of pattern recognition on things that feel ‘druggable.’” Given his acquisition track record and aggressive approach to bringing his innovative sciences to market, I felt like Unity was a solid choice for my one small speculative long-term position.
This made me miss swing trading because these were exactly the types I’d previously have held for a few days or weeks L (so nostalgic).
I went into it September 7th and four days later, it spiked and went up over 35%. I was of course too busy trying not to look at stocks, so I missed the entire thing. I saw it after it’d settled back down and I just held it as it continued to peter out, laughing every day as my maniacal mind was like HAH! Long-term sucks!! I finally said screw it and cut it loose a few weeks later.
So my cathartic moment came from a risky company you’re not even supposed to do buy and hold on anyway but I didn’t care, it was all I needed. I’d been chomping at the bit to go back to my constant equities analysis. And that little fireworks display at the end concluded my foray into trying to get into passive investing.
What does “you can’t beat the market” even mean?
The phrase “you can’t beat the market” is so annoying. Which market exactly and why is it always the S&P 500 that’s used as the benchmark to represent “the market”?
The widely held notion that it’s near impossible to beat the market consistently with active management and stock picking doesn’t make any sense because the market (S&P 500, by most standards) is actively managed. It’s comprised of an inventory of 500 stocks that’s constantly changing.
In an analysis by Morgan Stanley's Adam Parker, it was determined that on average, 22 companies, or 4.4%, are added to, or removed from, the index each year.
“In most years, 25 to 30 stocks in the S&P 500 are replaced,” says managing director and Chairman of the Index Committee for the S&P 500, David Blitzer. Or, as the WSJ calls him - David M. Blitzer: Stock Picker Behind the S&P 500.
It really is all about timing the market. Even the most passive strategies base a portfolio’s equity allocations on the investor’s time horizon. Mitigating the risk of market crashes via reducing stock allocations as the portfolio’s owner nears retirement is technically still a form of “timing the market”.
As trading technology continues to rapidly evolve, markets are changing right along with it. A 2017 Credit Suisse report emphasizes the importance of investor’s taking into consideration technology’s impact on shrinking corporate longevity.
In the 1950s, the average age of a company listed on the S&P 500 was ~60 years old. Today, it is less than 20. The average tenure of companies on the index is shrinking as well and has been trending down from the 1980s average of 35 years to 2016’s 24.
Long-term, passive strategies might have worked at one point. But right now, technology is making change happen faster and faster and the market is reflecting that.