I recently received an e-mail from a “wannabe” hold-n-hope investor. This particular investor expressed a belief that selling positions through stop-limit loss orders or with the benefit of a 200-day moving average only proved beneficial in 1929 and 2008.
I countered with the reality that reducing stock exposure via selling or hedging benefited investors in every bear market on record, including, but not limited to, 1901-1903, 1906-1907, 1909-1911, 1912-1914, 1916-1917, 1919-1921, 1929, 1930-1932, 1937-1938, 1939-1942, 1946-1947, 1961-1962, 1966, 1968-1970, 1973-1974, 1976-1978, 1981-1982, 1987, 1990, 2000-2002 as well as 2007-2009. In fact, even in the scores of instances where a 10%-19% correction resulted in a small loss when a hedge is removed or a “get-back-in” purchase is executed, one should not ignore the sleep-at-night comfort that the insurance provided. (Note: There are plenty of instances when taking measures to minimize stock risk in 10%-19% corrections resulted in small gains as well, including 1998 and 2011.)
Consider the fact that when we buy homeowner insurance, we willingly give up a small premium to protect against a monstrous property loss. We actually prefer losing the insurance premium, as opposed to seeing the home devastated by a hurricane, tornado or earthquake. And yet, if the worst should happen, the protection is in place to restore the residence. In other words, the small loss of that premium payment is the price that we pay for peace of mind.
In my 25 years of debating the merits of buy-n-hold versus buy-n-hedge/buy-n-sell, I still marvel at the hardened positions of buy-n-hold advocates. Insurance in investing endeavors is not necessary? Would they say the same about all of the other financial walks of life – health, property, casualty, disability, liability, long-term care, vehicle and so forth? Or would they not find those types of insurance necessary to maintaining their livelihoods?
Let us pretend, for an instant, that stop-limit loss orders and the 200-day SMA were only beneficial in the catastrophic circumstances of 1929 and 2008. Isn’t that enough? Do earthquakes and tsunamis come only once every 79 years with reliable precision? That sounds like a prediction to me, that the Great Depression and the Great Recession represented such extraordinary unlikely outcomes, that there’s simply no need to worry again until 73 years from now.
Here’s the truth: Nobody has any idea what will happen next. Nevertheless, if we are going to use a timeline in history to make future decisions, we might as well note that a typical bear market of 20%-plus stock losses occurs every four to four-and-a-half years. This bull market is closing in on six years. The average decline in a bear? 33%. If selling some positions at all-time records in a late stage bull is foolhardy – if employing a multi-asset stock hedging approach with assets that perform better than cash in moderate-to-severe downturns is foolish – I will continue to play the fool.
Still not convinced? Then you ought to get a gander at the Dalbar studies. Over a 20-year period ending 12/31/2012, U.S stocks annualized near 8%, U.S. bonds annualized near 6.5%. And the average investor? Only 2.3%. Ironically, the data are widely touted as proof positive that one should simply buy-n-hold through thin and thick.