Can a 'buy and hold' investment strategy still deliver?

published 4 November 2014

One of the most frequently offered pieces of investment advice is to buy shares and just hold on to them. This is also known as a buy-and-hold' strategy. Buy and hold has gained a lot of supporters over the years and it's not difficult to see why.

The approach could almost be renamed buy and forget'. After all, most of the evidence suggests humans aren't much good at selling when prices are high and buying when they're low (market timing).

By buying shares and just forgetting about them for a long time, you're free to let compound interest get on with its work and build you a tidy sum. You don't need to worry about share prices and their daily ups and downs.

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Well, that's the theory anyway. If you look at the long-term history, the evidence for a buy-and-hold strategy looks quite compelling. Even after the sharp price falls of 2008/2009, those who held on to their investments have largely been vindicated, as much of the lost value has been recouped and some have even made gains.

Then there's the mantra of investing gurus such as Warren Buffett, who claims his ideal holding period is 'forever'. All this is why buy and hold is often suggested as a great way to get rich slowly.

You can't beat the market

Unsurprisingly though, you won't find many professional investors or advisers promoting a buy-and-hold strategy. If they did, then there wouldn't be much work for them to do. That's why they claim that with their knowledge and skill, they can outsmart the markets.

Yet after all the tinkering and time spent analysing individual shares, these professionals often fail to deliver a better performance than you would get from a cheap index-tracking fund. (These are the funds that move up and down in line with the market.)

But what about the practicalities of buy-and-hold investing? Do you have the emotional strength to stick with it? It's easy to have lots of conviction when things are going well, but harder to feel confident when share prices are crashing all around you.

Looking back now, 2008 looks like a great buying opportunity. However, at the time you could have been forgiven for selling all of your portfolio in a massive panic.

Reinvest those dividends

If you hold shares for long enough and reinvest the dividends you receive, then history suggests this is a great strategy. Someone investing £1,000 in a basket of UK shares in 1970 who held on to them and reinvested the dividends would have accumulated over £126,000 by the end of 2013 an impressive average annual return of 12.4%.

That said, in recent times the evidencefor buy and hold has been lesscompelling. Since 2000, stockmarket investors have had to endure big set backs associated with the bursting of the technology bubble, the Iraq war, and the financial crisis of 2008/2009.

A buy-and-hold investor has still made money though: £1,000 invested at the start of 2000 would have turned itself into £1,722 by now a less impressive average return of 4.3% per year. You'd have been much better off owning a portfolio of government bonds.

Three alternatives approaches

1. Buy and sell

One of the main arguments against buy and hold is thatit ignores the times when shares get very expensive.An alternative is to follow a momentum strategy.

In a recent piece on the Forbes magazine website, investment manager Kenneth Winans looked at the performance of a buy-and-sell strategy between 1979 and 2013.

This works by selling shares if the S&P 500 index trades below its 200-day moving average and putting money into cash. Shares are only bought again when they trade above their 200-day moving average.

This attempts to capture changes in the price momentum of shares and it seems to do well especially when prices are very volatile. Over the time period, buy and sell delivered annual returns of 11.7%, compared with 10.3% for buy and hold.

2. Multi-asset investing

This means not having all your money in shares and allocating a target proportion of your savings to other investments, such as bonds, property and precious metals. When shares do well, they will go over your target allocation.

By selling and rebalancing back to the target, you can take advantage of high share valuations and reduce your risk compared with holding on. The same approach can work in reverse when shares fall in price and you rebalance by buying them.

3. Dividend compounding with individual shares

Instead of buying and holding a basket of shares, such as a stockmarket index, you can adopt a more focused approach. This involves building a concentrated share portfolio with just a few shares.

Here you keep an eye on the fundamentals, such as business prospects, financial conditions, and the valuation of the shares. As long as these are reasonable, then you hold on to the shares and buy more of them with the dividend income you receive.

This strategy works well with high-quality companies with strong, predictable cash flows. For example, buying shares in UK utility company SSE on 1 January 2000 and reinvesting dividends would have delivered an average annual return of 14% up until the end of 2013 trouncing the stockmarket.