I recently came across an article in the Wall Street Journal written by Burton Malkiel titled ‘Buy and Hold’ Is Still a Winner.  If you’d like to read the article, it comes right up when you Google-it.  The title of the article caught my attention for obvious reasons – Chladek Wealth Investment Strategy: The Numbers Don’t Lie.  However, when reading the entire article, there are actually more points that Mr. Malkiel and I agree on than disagree on.  I felt this recent WSJ article would be a good opportunity for me to comment on the points made in the article, and why I agree or disagree with each of them.

Many investors believe that success depends on skillful timing.  But no one-either professional or amateur-has ever been able to time the market consistently.  And when they try, the evidence shows that both individual and institutional investors buy at market tops and sell at market bottoms.  Market Timing is defined by the website investorwords.com as “Attempting to predict future market directions, usually by examining recent price and volume data or economic data, and investing based on those predictions.”  Like Mr. Malkiel, I agree that market timing is not a good strategy since no one can accurately predict the markets all the time.  While I don’t try to time the market, I do follow trends in the market.  Following Trends, by definition, is an investment strategy that takes advantage of long-term positive and negative moves that play out in the financial markets. A trend-following strategy will have a particular metric, or a series of metrics, that trigger buying and/or selling.  I do not attempt to guess the direction of the market.  For me, the goal of following trends is to be invested during the positive trends in the market, and sitting out during the negative trends in the market.  Trend following is not a buy and hold strategy, nor is it market timing.  As for the evidence, I would again refer you to the link above that shows the numbers don’t lie.

Many investors suggest that low-cost, passively managed portfolios are no longer useful, that today’s difficult investment environment requires active management.  Active or passive management can be viewed two different ways.  It can be used to describe the type of investments you use – actively managed mutual funds vs. passively managed exchange traded index funds (ETFs).  It can also be used to describe the investment strategy as a whole – actively monitoring, and adjusting as needed, the investments vs. buy and hold.  Mr. Malkiel is talking about passive management in terms of the type of investments being used.  I agree with him on this point.  According to the Standard & Poor’s Indices Versus Active Funds Scorecard (SPIVA) 2008 study, 71.9% of active Large-Cap funds underperformed the S&P 500, 79.1% of active Mid-Cap funds underperformed the S&P Mid-Cap 400, and 85.5% of active Small-Cap funds underperformed the S&P Small-Cap 600 Index.  If actively managed funds fail to beat their index benchmark, and don’t protect their investors from losses, than why are investors paying higher fees (operating expenses) to be invested in them?  The average actively managed mutual fund has operating expenses of 1.43%, where the average broad-based ETF has operating expenses of 0.18%.

Buy and hold investors in the U.S. stock market made an average annual return of 8% during the 15 years from 1995 through 2009.  But if they had missed the 30 best days in the market over that period, their return would have been negative.  I understand Mr. Malkiel’s point here, but I also believe he is leaving out another very important factor.  What if investors had missed the 30 worst  days in the market of that period?  This is what my investment strategy attempts to do, and is a major factor in why the strategy would’ve greatly outperformed a buy and hold strategy in the S&P 500 over the last 21 years, as outlined in the investment strategy link above. 

Market strategists called for a sharp market decline in late August 2010 as technical indicators were uniformly bearish.  The market responded with its best September in decades.  While I’m sure there were some technical indicators calling for a bearish September, the S&P 500 50-day EMA rose above the 200-day EMA on September 16th, which is a buy signal using my strategy.  Using my strategy for the S&P 500, you were able to avoid the negative performance by selling on August 11th, but were back invested in the middle of September to take part in the ‘best September in decades’ that Mr. Malkiel is referencing.

While no one can time the market, two timeless techniques can help – Dollar-cost Averaging and Rebalancing.  I agree with Mr. Malkiel on both of these techniques, with one caveat – buy only when the current price is higher than the 200-day EMA and the 50-day EMA is higher than the 200-day EMA.  Why would you want to invest new money in an investment that is obviously on a downward trend?  It would make more sense to wait for it to start trending upward before investing new money.  Dollar-cost averaging and rebalancing are techniques used to take the emotion out of investing.  A person’s emotions are one of the biggest obstacles to successful investing, which is why having a specific strategy in place is paramount.  It is also why most people hire investment advisors so that their emotions don’t ruin their portfolio.  The key is finding an investment advisor that is competent and disciplined.

Diversification has not lost its effectiveness.  Again, I agree with Mr. Malkiel.  Diversification is essential, as long as the investments you are diversified in are trending upward.  In the event there is no investment trending upward, which is extremely rare, there is nothing that says you can’t have all your investments in cash instead of being invested in something that is trending downward and going to lose your money.

Low-cost passive (index-fund) investing remains an excellent strategy for at least the core of every portfolio.  Index mutual funds and their exchange-traded-fund (ETF) cousins do not trade from security to security, and they charge rock-bottom expenses (usually well below one-tenth of 1%.)  The one investment principle about which I am absolutely sure is that the less I pay to the purveyor of an investment service, the more there will be for me.  As Jack Bogle, founder of the Vanguard Group, says: “In the investment fund business, you get what you don’t pay for.”  I couldn’t agree more!  This supports my reasoning for using ETFs that I addressed above.  It also is the reason why I charge less for my investment management services than the average advisor.

This blog post has touched on the main points that Mr. Malkiel made in his article.  However, I would highly encourage you to still read his article as there is more supporting information for using low-cost index funds versus actively managed mutual funds.  If you have any follow-up questions about this post, or Mr. Malkiel’s article, please don’t hesitate to contact me at 913.693.7918 or [email protected]

As always, if you would you like a free analysis of your current investment portfolio, please contact me today to schedule your appointment.

John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals.  For more information, visit http://www.chladekwealth.com.

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