The 'buy and hold' investment strategy doesn't work

The back page of last week's National Enquirer ran a very tempting advertisement indeed. A mystic offered to grant all the wishes of every reader. Free! You just had to fill in a form giving your personal details and listing the five things you most wanted (a specific amount of money within a specific amount of time, a new boat or house, a holiday of a lifetime or just "financial security"), send it off with no cheques or cash enclosed and wait.

I'm pretty sure MoneyWeek hasn't much of a cross-over readership with the National Enquirer, but I think this proposition may remind you all of something. Yes, it's the financial services industry. Financial advisers don't use quite the same wish-fulfillment methods. But most make much the same promise list your financial goals, do as they say, and a better life will appear.

Sure, they won't promise a set amount of cash on any given day, but they do suggest that you're likely to get an average return of 7% a year from the equity markets, which will give you the same financial security (or holiday of a lifetime) our mystic is offering. And while they aren't as explicit about calling their services "free", the average independent financial adviser (IFA) still doesn't ask for cash up front (with, of course, the honourable exception of fee-only IFAs).

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Unfortunately, that doesn't mean these splendid opportunities won't cost you. Reply to the National Enquirer advertisement, and you'll end up paying out, just as surely as you still end up paying away a huge percentage of any of your returns in commission when you take advice from an IFA.

Worse, your dreams won't come true either. No mystic can deliver on your financial wishes. And odds are your IFA can't either. Anyone in any doubt need only look at Tim Price's most recent Price Report. Tim points out that the 20-year period between 1980 and 1999 is the only time "in stockmarket history when the market delivered on average annualised real returns of between 8% and 10% a year". Those returns, over such a period, "have never occurred before". Instead, most 20-year-period returns "cluster either side of zero". Even more shockingly, in many 20-year periods, stocks have suffered pretty big losses (ie, 1960-1979, or 1900-1919).

Most investors, having invested mainly over the last 25 years or so, are heavily infected with "recency bias", and so don't really get this. Tell one today "that there was a realistic chance that he could be invested for two decades and still be out of pocket, and the chances are he'd laugh at you". Tim's conclusion is that we have to "stock pick for absolute returns". It should also remind us that history suggests that the top investment strategy of the 1980s and 1990s, buy and hold, doesn't work. However well picked a stock or a market is, odds are that if you hold it for too long, you'll end up losing money.