The Worst Market Timer of All Time Outperformed You

There is a growing sentiment that the old investing strategy of "Buy and Hold" is dead. Now it is a little unfair for pundits to make such a sweeping statement. "Buy and Hold" is a term that should never have existed. It has been extensively used (and probably created) by the professional stock pickers of the day to justify their high management fees and "active trading" skills and is almost always used in the negative sense, such as: "Why would you want some one to use a "Buy and Hold" strategy when you can pay us large fees to churn your portfolio as much as possible?" (Ok, maybe no one has actually said that).

And if the commentators liken 2008 to the final nail in the coffin of the "Buy and Hold" strategy then someone needs to start reading active managers their last rights because, on average, not only did they lose as much as the market in 2008, you paid them more to do so!

But I digress. Getting back to the "Buy and Hold" strategy. This strategy is not to be confused with a long term exposure to equities or Modern Portfolio Theory (MPT) which it often is meant to refer to. The true practitioner of MPT will be re-balancing your portfolio when required and most likely BUYING equities during market downturns. This is far from the notion of "Buy and Holding" a portfolio into perpetuity.

However; The reoccurring theme in good investment management whether you are a stock picker or portfolio manager SHOULD be that no one can time or predict the market consistently, just ask investors who entrusted their money to PhD's and noble prize winners running Long Term Capital Management. The risk/return profile of equities is based on cash flows generated by the underlying companies; returned to you (the investor) through dividends or capital appreciation. Return is NOT based on timing the market. You should not buy and sell equities anymore than you would buy and sell your own company with the ebbs and flow of the economy.

Which brings me to this weeks graph and the title of the blog. What would you say if I asked you to guess the return to the worst market timer of all time over his/her life of investing in the S&P 500? -5%, 0%, 2%? The answer may surprise you.

The chart below was made based on S&P returns with reinvested dividends. I went back as many recessions as I thought was reasonable for the life of an investor which took me to 1973. That is 38 years of investing. A pretty typical time horizon for an investor, if anything a little short. I then based this hypothetical person's investments on the year the stock market first posted negative returns due to an economic recession. For example; the first $1 investment took place at the beginning of 1973, even though the recession did not formally start until the end of 1973. The reason being the market was down 15% in 1973 and was the first market reaction to the recession. This person made $5 worth of investments over his lifetime. All the in same manner i.e. the first negative year surrounding a recession. So how did they do through 2010?

They did pretty darn well considering.  9.68% time-weighted compound annual return.  This is right in line with the traditionally expected 10% return for equities. $5 has turned into $64.  And this is considering we have not fully recovered from the present recession.

So how did you (the market timer) compare to the worst market timer of all time?  Has your portfolio beaten almost 10% annual return?  Probably not without taking more risk i.e. international stock, small cap stock, etc.  It is highly unlikely that you did.  There is obviously not a direct comparison here as your investment horizon will not match up with this hypothetical person but the graph supports plentiful research that timing the market can not beat long term equity exposure.  The only timing you should do is ADDING to equities during recessions or market downturns as your portfolio needs to be re-balanced.  And remember, the return of the graph is ONE type of exposure to equities over a long time period.  A real life portfolio would include multiple different exposures to different asset classes with more or less risk and corresponding higher or lower returns.

What if you don't have 38 years?  Even if you portion the above investments into 10 year time frames after each $1 investment your annual return is: 12%, 17%, 18%, and 0% (remember still in a recession).

I will leave you with this: The return to the same investor above if he made $1 investments after the first negative S&P year going into a recession until he used up his $5 would have been 11.73%.  A seemingly small annual increase, but it equates to a ending dollar value of $164. 


So..... maybe you should start buying equities?