Will Retail Investors Continue to Buy and Hold Stocks?

It’s still too early to tell whether the stock-market crash of the past couple of months has done any lasting damage to the conventional wisdom that a buy-and-hold strategy applied to a diversified stock portfolio is generally a very good idea. But it is worth pointing out that a couple of the names one might associate with the idea, when you look a bit more closely, aren’t nearly that simplistic.

For instance, consider Henry Blodget, who wrote The Complete Guide to Wall Street Self-Defense for Slate back in 2004 — something full of common-sense advice for long-term investors. He recently posted a blog entry headlined "Time To Abandon Buy And Hold? No: Time To Buy", in which he seems to advocate at least some attempt at market timing:

The Japan news is profound and disturbing, but it does not change the basic equation: price matters. Buy stocks when they are cheap, sell them when they are expensive.

How does a normal retail investor know to sell stocks when they’re expensive? Through rebalancing: once a year or so, look at your portfolio and, so long as you can do so without too much in the way of adverse tax consequences, bring it back to whatever kind of big-picture asset-allocation setup you wanted all along. If your stocks have gone up a lot, you might sell some, or at least invest no more money in stocks; if your stocks have gone down a lot, you’ll buy more. So that’s a good way of buying low and selling high within a basically buy-and-hold framework.

Jason Zweig, on Saturday, had another interesting datapoint, this one relating to Warren Buffett:

As recently as 1995, 73.5% of Berkshire’s total assets consisted of a portfolio of publicly traded stocks that (at least in theory) any investor could have replicated. As of June 30, though, Berkshire’s stockholdings made up just 25% of its total assets.

Again, Buffett might not have been selling stocks, exactly, but he certainly hasn’t been buying them with anything near the alacrity with which he’s been buying less marketable assests. The net effect is similar: he was quite low on stocks when the crash came.

In a world where many retail investors have unthinkingly bought stock-market funds just because they’re meant to be the best long-term investment, it’s sobering to realize that it’s more complicated than that — but then again, right now it’s pretty obvious to everybody that buying stocks isn’t always a great investment. And right now we’re in a pretty unprecedented situation where millions of people are buying stocks within their defined-contribution pension plans, in the hope and expectation that those stocks will rise so much over time that their savings will grow into enough money to live on in retirement. That’s a very big, very crowded trade — and one which is pretty much unprecedented, since until quite recently most pensions were defined-benefit, not defined-contribution.

The fact is that no one has a clue what stocks are going to do over the next decade or two. We could be entering another bull market; we could just be at the beginning of a huge bear market. What’s clear is that buying stocks is a risky way to invest your life savings, and that a lot of people who took on that risk were not really clear on exactly how much their savings could fall.

But the good news is that, at least if I can rely on a few conversations here and there over the past weeks, most retail investors are reacting to the stock-market crash in exactly the right way: by not even opening their brokerage statements. Right now, knowing the mark-to-market valuation of your stock portfolio is not a useful piece of information to have; it’s much more likely to drive you to do something silly than it is to help you do something prescient.

And looking forwards, it’s clear that the US savings rate is going to start rising in the coming years. That, too, is good news, in a world where there’s no such thing as a free lunch. If you want to save money, save money. Don’t place too much trust in the market to make your money grow, since there’s a good chance the market will end up moving in entirely the wrong direction.

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