Does Buying and Holding Work?

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There are a lot of people that think that the stock market is all about timing. That’s because the market has been known to go up and down more than a roller coaster at a Six Flags theme park. All of the volatility in the marketplace has made many to believe that buying and holding equities is a losing game.

If we were to look at the past performance of the TSX over the last ten years, you would have to wonder what the heck happened?

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It two words to describe this “it sucks!” If you were to buy and hold over the period of ten years the gain was only 21.46%. Along the way you lost half your money and probably sold it all anyways so you’re left with a loss of 50%. One has to really wonder, why save any money at all and invest it in stocks? It would have been far more lucrative had you taken the money and thrown it into real estate.

That last point is completely true. Over the last ten years, real estate in Canada has boomed and would have probably net you gains in the hundreds of thousands through leverage. One would have to say that there has been no better investment than real estate in Canada. Alas, our American friends probably wouldn’t think the same.

With all these negative points, the real question that comes to mind is whether or not the buying and holding strategy is a failure? The answer to that is it depends.

Diversification

I took a very narrow look at equities because for most Canadians, we focus all our equities on the Canadian stock market. There is a strong bias towards Canadian equities by financial advisers at Canadian financial institutions. I would too because I would want my customers to invest in my company. The truth is the Canadian economy contributes very little to the global economy. In fact, Canada only contributes around 2%.

By keeping all your investment in Canadian equities only, you are exposing yourself to increase risk, because the Canadian stock market is predominantly compromised of financials and energy companies. Additionally you’ve restricted yourself to a very small marketplace.

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A quick look at the S&P index over the last ten years will show performance that has been a bit better.Despite the big crash in 2008, the S&P has still performed relatively well with a 67% gain over the last 10 years. That’s still a 5% gain per year and throw in the 2% dividend and you’re up to 7%. Respectable.

By further diversifying into bonds the returns don’t look as abysmal. The chart can attest t the capital gains achieved by bonds over the last 10 years:

Bonds have actually had a really good return over the last ten years as interest rates have fallen and bonds in turn have appreciated in value to reflect the lower interest rates. Had you held bonds for 10 years, the capital gains would have been 56.9%, but you would also have collected interest along the way.

Let’s look at it this way. If someone invested $10,000 in a 60% bond, 20% US and 20% Canadian balanced portfolio, over the last decade that portfolio would be worth $15,184. That’s just with capital gains and not including any dividends you would get as well.

Now if you compare that to holding just the Canadian TSX index, you’ll understand why having a diverse portfolio is actually better than just investing in Canadian equities alone.

Rebalancing

Diversification helps reduce risks and also exposes the investor to other markets that may perform better relative to its peers. This form of strategy will help with gains, but a more powerful way of reaping rewards is through rebalancing.

In this scenario we’re still holding onto our investments. At no point are we actually selling our investment portfolio. The strategy around rebalancing is to ensure that the goals of your original investment plan are still kept intact.

Let’s just take a simple example of rebalancing whenever a significant event happens that causes our investment portfolio to go out of balance. If we look at the above charts, the crash that occurs in 2008 is a prime example.

Let’s assume that same balanced portfolio of 20% Canadian, 20% US and 60% bonds. Starting out with $10,000 the 2008 crash would bring our overall portfolio down. When something like this happens, someone that is dedicated to buying and holding wouldn’t fold and sell his portfolio. It’s smarter to rebalance.

Rebalance

So rather than freaking out and running for the exits, rebalancing the portfolio to the original 60% bond, 20% Canadian and 20% US is the proper solution to any crazy market correction.

Assuming no other crazy fluctuations along the way, after rebalancing at the trough of the crash a portfolio of $10,000 in today’s money would be worth $17237.30. That also represents the amount without dividends included in the calculation.  Notice how rebalancing is extremely powerful in boosting long term returns and to achieve this only takes a few minutes to do.

Doing Nothing Doesn’t Work

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To put it simply, sitting and do nothing while holding a single investment is a strategy that just doesn’t work. Unfortunately for a lot of people in Canada, we only invest in Canadian mutual funds or equities. This leads to more risk, less diversification and worse of all, lower returns.

It’s not that buying and holding doesn’t work, but buying and holding just one asset is a terrible strategy. As I have written, the last ten years would have provided abysmal returns had you only invested in Canadian equities, which is why many individuals have forgone investing in equities completely.

Having a balanced portfolio helps, but it doesn’t do enough when there are huge fluctuations in the marketplace. When these events happen, a balanced portfolio will certainly help blunt the losses, but to maximize the performance of your portfolio, a small adjustment still needs to be made to rebalance the portfolio. This is something many individuals fail to do.

This leads to the conclusion that at a minimum you should always try to rebalance your portfolio. Make sure that you maintain the ratios based on your risk profile and investment goals. If this activity is something that you are not comfortable doing, there are many robo investment services like WealthBar or WealthSimple that can do it for you for a fee.

It doesn’t take a lot of effort to keep your investment portfolio balanced. It doesn’t require hours of your time per day. It could be as simple as taking an hour for two days during the year, once in January and perhaps another in July to rebalance. This isn’t a substantial amount of time to devote, but it will certainly help make your investment portfolio stronger.

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