Buy and Hold Debunked: What Your Broker Isn’t Telling You
Friday, December 5, 2008 16:36I’m amazed at the amount of optimistic propaganda peddled by the mainstream media as well as major investment houses. Countless are their graphs and comparisons which claim that buying and holding stocks is the best way to grow capital. They tell you that the average return of the stock market is 10% and if you just wait things out, you’ll be OK.
What they don’t tell you about their 10% figure
1. It assumes dividend reinvestment. Without that, the number is reduced to 6 or 7 %
2. It does not account for commissions or fees (or taxes of course).
3. The time period of their research is cherry picked. You’ll often see the first year of data as the year of a major market bottom (so to greatly inflate the number). Further, you’ll probably never see a study that goes back to 1900. Why? It isn’t because they don’t have the data, but because it throws their numbers way off. Some reports only go back to the early 80s which should be disregarded at all times as the 80s-90s bull market was the greatest in history.
[Click any image for a better look]
So what are the real numbers?
Anyone with a financial calculator can easily debunk the 10% myth. In 1900, The Dow Jones was worth 48, and worth 8,000 in 2008 (108 years later). Average annual return is 4.83%. (See Graph Below). Remember, this number is even overstated as fees and commissions are not accounted for.
Recovery Time in a Structural Bear Market
Since 1900, the Dow Jones has experienced 3 structural bear markets. The third one began in 2007. It took 26 years to recover from the first and 18 from the second (See Below). The average time to recover is 22 years. Remember that the next time they try to call a bottom on CNBC
What is a structural bear market?
Most investors think of a bear market as a quick and temporary phenomena because their frame of reference only goes back 25 years. The fact is that from 1983 to 2007 we were in a structural (long term) bull market. All bear markets within this time were only cyclical (relatively short corrects within an overall structural bull market). During this period, you were, in fact, rewarded for holding through the dips.
Structural bear markets are much longer in duration.
Is this a structural bear market?
We think it is. The 24 year bull market (structural) is about on par with the average in duration (trough to peak). In terms of % gain, the recent bull market was almost identical to the last (See below).
A tell tail sign that we’ve entered a structural bear market, rather than a cyclical one is that a multi-decade uptrend has been broken (See below). This does not occur in minor, cyclical bear markets. As bad as it was in 2000-2002, the uptrend remained. This is no longer the case.
“This time is different”
There’s an old saying on Wall Street. The most dangerous words are “This time is different” and I think that there is some validity to the saying. My argument, however, is not that this time is different. If you studied the history of the stock market you would know that this time is the same! The stock market experiences major 20-25 year cycles and it’s important to know which one you’re in.
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Craig Hodder says:
December 5th, 2008 at 5:57 pm
Here’s what I don’t understand. If the calculations are correct and the average gain is 4.83% (the math does work, I have a calculator )…
That’s not even equivalent to the rate of inflation! How is it possible that the stock market has survived 108 years, if it cannot even compete with the rate of inflation??
chartingstocks1 says:
December 5th, 2008 at 9:11 pm
My point exactly
The fact is that when the market turns and enters a bull market, greed takes over. You hear of the 10-20% returns people are making and so you enter.
Demand for stocks in bear markets change dramatically. P/E ratio is the best gauge of demand. It’s really the demand for a companies earnings. In a structural bear market P/E’s can get as low as 5-7X.
We’ve had a long bull market (24 years). P/E ratios got as high as 36 in 2000. We’re going to have to work out the excesses.
You can make alot of money in the stock market. If you can buy at the right time. Most people buy at the wrong time.
sharpin says:
December 6th, 2008 at 12:43 am
Craig, there is always a new crop of ignorant morons investing in the market who don’t understand the fundamentals.
Geoffrey Transom says:
December 6th, 2008 at 1:14 am
I’m a bear (who has thought since 2000 that the US would be destroyed by its own idiocy… and I was saying in 1997 that Greenspan was a complete idiot).
So that’s by way of pointing out that I don’t disagree with your cventral thesis. BUT you’ve stuffed up here.
You’ve used a price index instead of an accumulation index. Accumulation indices account for dividend reinvestment, price indices don’t.
It’s fine if you want to assume non-reinvestment of dividends – after all, it’s pointless assuming that a person held their wealth in stocks for 100 years without touching it. However you at least have to include them in your return calcs.
Cheers
GT
GT’s Market Rant
(formerly Head of Equities Research at Australia’s largest online community of traders and investors, and the guy who identified CDOs as a source of balance sheet poison and economic cataclysm… in 2004)
Wolfenstein says:
December 6th, 2008 at 6:09 am
Why would anyone sink one penny into this dead market? Hey, if you want to lose all you saved, be my guest. Only an idiot would listen to the propaganda like ravings from CNBC.
spunkyruss says:
December 6th, 2008 at 8:58 am
The move from pension plans to 401k plans has forced the American worker to prop up the stock market.
In many instances an employer will only make contributions towards a worker’s retirement if the worker invests in the market.
Forcing workers to invest in the market also perpetuates the myth of 10% returns.
Anyone that questions the lie is disregarded by the multitudes that have invested in the market.
If the multitudes entertained such questions then they would be forced to admit that they’ve been duped.
It is difficult for the multitudes to admit that the emperor has no clothes.
It is impossible for the multitudes to admit that they have no clothes either.
bob adams says:
December 6th, 2008 at 9:13 am
By the chart above, in 1929 before the stock market crash, the Dow stood at 380.33. The fixed price of one ounce of gold was $20.67. Therefore one could “buy” the Dow for the sum of 18.4 oz. of gold. Yesterday (12/05/08)the Dow closed at 8635.42. On the website http://www.goldseek.com yesterday’s final ask price for one ounce of gold was $757.85. Bear in mind this was the COMEX ask price. I dare anyone to go out and take physical posession of an oz. of gold for that price. You can’t do it. Nevertheless for our calculation we will use the COMEX price. Now divide the Dow closing number by the cost of one oz. of COMEX gold. Voila! You can buy the Dow for 11.39 ozs of gold! The Dow is worth less now than it was in 1929. How is that for 79 years of long time investing?
chartingstocks1 says:
December 6th, 2008 at 10:53 am
GT..most people don’t reinvest the dividend…and even if they did, the numbers would be overstated. do you know how many stocks are in the original dow jones ?? ONE..GE..
When the stock does poorly, it’s removed from the index
Rick says:
December 6th, 2008 at 12:08 pm
What intrigues me is how the major indexes drop stocks after they crash…and replace them with new up and comers….and so on and so on.
The game is rigged. The average is rigged to go up, decline…and get adjusted so it goes up again. Buying and watching and moving to new winners would be the smarter thing to do.
What would those indexes look like if they were kept in? Low!
i.e. In the U.S. Liz Claiborne was just dropped. In Canada, Nortel was conveniently dropped.
R.
Joe S. says:
December 6th, 2008 at 4:24 pm
I guess for those who think that the stock market ought to be an automatic money machine, there are some points to make.
1. Successful investment requires intelligent, informed decision making (or luck). There’s no such thing as a free lunch and the idea that you can superficially invest in a number such as the DJA and automatically make more than the inflation rate is not only naive, it’s unjust. What, you should get a $100,000 increase your 401(k) just for sitting on your ass, while someone else is digging ditches at eight bucks an hour? No, you have to work for your money, and that’s true in the market too.
2. The economy has stagnated for the past thirty years. It takes both parents working outside the home to support a family now. Market gains have been largely inflationary and on paper. That’s why your mortgage costs more than your house is worth.
3. Simple logic tells us that all companies and industries eventually go out of business so that in the long run Buy & Hold goes to zero. As an extreme example, some day the sun will die and the next day the DJA will be worth zero. But you don’t even have to go that far to realize that buy and hold may not survive the collapse of the dollar as global reserve currency or the rise of China as the dominant economic superpower.
4. I’ve heard some successful investors say that an intelligent strategy of carefully studying a company, its industry, and related technologies can pay off with above average returns. But it takes more skill and knowledge than I have.
5. “Behind every great fortune is a great crime.” Excepting Bill Gates, Stephen Spielberg, and too few others, I’m afraid that’s true. Most of the billionaires in the world got rich one way or another through political connections. You can tell which ones by how wonderful the media claims they are. Too often these over-hyped Heroes of Capitalism are simply money-launderers for the Federal Reserve. The game is rigged and they get the money in the stock market. And if the market tanks, they get a bailout. If you don’t believe that, you obviously just got back from Mars.
6. If you want to get rich, come up with a useful new product or offer superior service. Or buy a lotto ticket or marry well. Don’t think the path to riches is through a bokerage. These days brokers are actually pressured by their supervisors to push products onto their clients that their firms are attempting to unload. In other words, they want you to do with your money the exact opposite of what they’re doing with their money. What’s wrong with this picture?
7. Get out of the market, dammit, and don’t come back. Sure, just by chance you could time the bear and bull exactly right, but if you have that kind of luck then skip the brokerage fees and just buy that friggin’ lotto ticket. Ya hear?
Geoffrey Transom says:
December 6th, 2008 at 10:38 pm
chartingstocks1 on December 6th, 2008 10:53 am;
It’s true that most don’t reinvest dividends – that is why the appropriate estimate at long-term stock returns is equal to the long-term average price-only appreciation (as measured by the index) PLUS something to account for the dividend.
So for each year, the total return (assuming ZERO dividend reinvestment) would be (It/It-1-1) + d[t] where d is the dividend yield. Create a series based on that, and get the geometric average, and over the long term you get a number like 7% or so (i.e., about 4% real return).
I used to have a decent Excel spreadsheet (created by Shiller, I think) which had US numbers going back to 1871. If I can dig it up, I will update it and do the calcs properly and let you know…
Obviously dividend reinvestment is a BAD thing during period like 1996-current and in the 1968-82 period… stock went nowhere, but each dividend reinvested went further backwards.
Index membership changes, sure… we just assume that investors re-balance their portfolios to reflect the new index membership.
Cheers
GT
GT’s Market Rant
Geoffrey Transom says:
December 6th, 2008 at 10:46 pm
Joe S. – if you invest passively, you’re not ’sitting on your ass’. You’re simply putting your savings where you think they will appreciate the most.
ALL deposits should pay a rate greater than the rate of inflation: if they don’t then you are not being compensated for ‘giving up’ the chance to consume today.
In fact, that is what caused the problems we now face: the Fed interfered with the short run price of capital (and therefore the entire yield curve) which meant that SAVERS received negative real returns. So savings FELL.
Furthermore, people realised that since real rates were negative, the ’statically optimal’ thing to do was to get access to as much CREDIT as possible, and then spend it.
The problem is that the world is NOT static… eventually there is an upper bound for debt, past which an economy becomes unstable. the US hit that point in about 1997, and it is only massive monetary stimulus since then that has kept all the balls in the air.
Cheers
GT
GT’s Market Rant