3. Performance: Trend Following vs. Buy-and-Hold
For years and years a “buy-and-hold” investment strategy worked pretty good for long term investors. With the exception of a couple of hiccups (the early ‘70s and the early ‘80s), the stock market continually moved higher. Investors could buy quality stocks or mutual funds, tuck them away and forget about them - they were going to increase in value as the markets rose. Investing was easy!
That all changed during the spring of 2000. In March of that year, the “dot.com bubble” burst. As the high flying internet stocks crashed left and right, they dragged the rest of the market down with them. The ensuing bear market lasted almost 3 years, until October of 2002. The S&P 500 went from a high of 1552 in 2000, to a low of 768 in 2002 - a 50% drop. Folks who had planned to retire around that time found that they couldn’t afford to: their buy-and-hold strategy had cost them almost half of their nest eggs!
In March of 2003, a 4 1/2 year bull market started. Stocks moved steadily higher and once more investors were convinced that “buy-and-hold” was the best strategy for their retirement plans. Investing was easy again: everything was going up! Then along came the end of the “housing bubble” and the market crash of 2008.
The S&P posted a high of 1576 the second week of October of 2007. The very next week, it began to fall. In March of 2009, the index bottomed at 666. In 18 months, the market had dropped over 900 points, almost 58% down from those October highs. Once again, folks looking to retire around that time found that they had to keep working. Many who had retired just before 2008 found they had to go back to work as their nest eggs were torn to pieces.
Since 2009 the index has risen - in fits and starts - back to 1500 (as of early February 2013). That’s still almost 80 points lower than those 2007 highs and almost 60 points lower than the 2000 highs. Talk about treading water…
The “investment establishment” has been busy lately telling folks that average 401k balances are back to pre-2008 levels, as if the buy-and-hold strategy they continue to tout is responsible for the comeback. In fact, the S&P 500 traded in the 1400’s as far back as July of 1999, so buy-and-hold investors have had almost 14 years of zero market gains, other than the cheaper shares bought during those 2 market downturns. Most of the increases they’ve seen in their balances have been due to their contributions, their company’s match and any reinvested dividends they may have received.
During that same 14 year period, trend followers have enjoyed market returns averaging 5 to 15% or more annually, not including their contributions and company matches. They earned those returns by following the trends: they were invested in stocks/stock funds during the 2 bull trends (2003 - 2007 and 2009 - 20??) and they moved their moolah into safe investments - cash and bond funds - during the 2 bear trends (2000 - 2003 and 2007 - 2009).
These returns were achieved within basic 401k retirement plans. Independent trend followers racked up even bigger gains during that time. Big trend following firms really excelled during the period: Dunn Capital, Clarke Capital Management, Abraham Trading and other large firms consistently posted double digit returns for their investors.
> Let’s hold on right there for a minute! When it comes to statistics, we all know what Mark Twain said - and investment performance statistics are no different. Google “investment performance of trend following vs. buy-and-hold” and you’ll get a gazillion results (actually we got 160,000). We have to be careful when comparing those results because they are not always “apple-to-apple” comparisons.
> “Buy-and-hold results” usually refer to long only, stock heavy portfolios. “Trend following results” refer to portfolios that go long and short futures, commodities and stocks. Of course the results will be varied!
While 401(k) plans don’t provide us the option to short the market or buy commodities, a basic trend following method will still work nicely: in 2008, while the stock market crumbled, our 401(k) had 5% gain (not including contributions and company match!).
Suffice to say that buy-and-hold is dead, it just hasn’t been buried yet. Could it make a comeback? Yes, it’s certainly possible that the stock market could go on another 20 or 30 year run. But the neat thing about using a trend following method is that if buy-and-hold does come back, we’d already be “in” because we would already have been following that trend!