Which Investment Strategy?

Buy and Hold Strategy Has Failed

Many investors are reconsidering whether buy and hold is the best investment strategy. An investor who employs a buy and hold strategy buys stocks and hold them regardless of market volatility; believing that in the long term the market will provide a fair rate of return. The opposite of buy and hold would be day trading. These are the two investment strategy extremes and neither are wise strategies for most investors with long term goals.

A buy and hold strategy does well in bull markets when stocks are consistently rising. But the reality of the stock market is that stocks go through long periods where values decline or stay flat. Sometimes these periods last a couple of decades. Usually these periods are preceded by periods when stocks become very expensive and overvalued when compared to their historical relationship to earnings, cash flow, book value, etc.

Why have most mutual funds, pension funds, and investors done so poorly the past decade? Because investors and portfolio managers have not adapted to the environment we are in. Holding overvalued assets and not increasing asset allocations to undervalued assets has made this era of flat markets and increased volatility a recipe for wealth destruction.

Best Investment Strategy

The best investment strategy is one that allows an investor to take advantage of volatility by being more conservative when an asset price is high and more aggressive when an asset price is low.  This is called an active or tactical asset allocation strategy. Years of declining and flat prices can be mitigated because exposure to assets that are significantly overvalued is reduced. Lowering your asset allocation to overvalued assets can reduce the damage of bear markets and preserve capital for investment when the market heads upward.

The greatest advantage of a tactical asset allocation strategy is the flexibility it gives an investor to keep losses small in a bear market. By avoiding large losses in a portfolio, an investor not only loses less money, put preserves capital to take advantage of compounding during the next rally. Think of compounding this way; if an investor loses 50% of a portfolio, it takes a 100% gain just to get back to breakeven. If an investor loses 10% of a portfolio, it only takes an 11% gain to get back to breakeven.

The best investment strategy is a tactical asset allocation strategy because flexibility makes it superior to a simple buy and hold strategy!