Daily Speculations

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The Chairman
Victor Niederhoffer

09/22/2004
Thoughts on Buy and Hold

If I had a dollar for every time someone pointed out that the Dimson, Marsh and Staunton (see "Triumph of the Optimists" link below) results or Lorie results on buy and hold were biased because "index funds weren't available so you had to buy individual stocks back then", I'd be a wealthy man. Or, "if you bought stocks in 1968, it would have taken until 1984 before your inflation adjusted return was positive", I'd be a wealthy man. As for the latter, of course you can pick a starting and ending point where any series with a 10% per year drift and a standard deviation of 15%,adjusted by a third series with a 4% drift will show a long period of decline. That's guaranteed with random numbers. As for the former, that's a variant of the non-representatives fallacy. Only someone who didn't read the original highly recommended book could fail to recommend it. However, I would point out that mutual funds were quite popular in the 1950's and 1960's. Indeed a famous study in the JASA as of the time showed that there was no consistency in mutual fund rankings as of the 60's and used a tremendous sample. Buying diversified baskets of stocks was also quite popular back then. Furthermore, the correlation between mutual funds' performance on a year to year basis and the S&P 500, as well as the complete enumeration of all stocks on NYSE, and English equities, that Dimson and Lorie worked on has to be on the order of 95%. The point is that any random portfolio of ten or more stocks would have shown the same expectation and converged in returns to the various index funds. All these ad hoc critiques of the Dimson and Lorie complete enumerations are armchair speculations that have no statistical or practical basis and completely miss the point that buy and hold gives you a 6% or so real return per year, and that being out of the market for any length of time is almost certain to be highly detrimental. The same for following technical indexes that advise you to be out of the market for anything but a New York minute.

Note! B&N is offering Triumph of the Optimists at excellent price of $79.60. Click on title for link.

9/22/04
Re: Buy and Hold from James Sogi

My father would always say to me when I was a kid, "Invest with your seat not your head." Back then we had paper certificates to represent shares of stock that came in the mail when you bought shares. The idea was to sit on them, for a long time. Buy and hold. He did. It worked. You'll have plenty of time for family and friends while all the employees and managers and Ceo's of your companies work round the clock for you and send you the profits every quarter. What could be better?

9/22/04
Barry Gitarts Adds:

I agree that the case for buy and hold is biased without much evidence to back it up. While the prices of stocks have over the long run gone up, had you been someone who got caught in the market after the South Sea Bubble in 1720 you would have endured a 60 year period in which stock prices were declining. Stocks eventually started up again, but 60 years is a lifetime. Before the South Sea Bubble the majority of economists were advocating to buy and hold stocks; during the 60 years after, the majority of economists said you could not buy and hold stocks because they eventually go down.

9/22/04
Elroy Dimson Responds:

Barry Gitarts says: "Before the South Sea Bubble the majority of economists were advocating to buy and hold stocks". Stock trading commenced in London in 1698 in Jonathan's Coffee House. Economists didn't exist then: Adam Smith was not born until after the South Sea Bubble. There were no economists to give advice in 1720, and there was no prior 60-year history. Like Irving Fisher's famous October 1929 prediction ("In a few months I expect to see the stock market much higher than today"), economists' long-term predictions are often wrong. So if there had been markets and if there had been economists in 1720, we do know one thing. Barry Gitarts' imaginary economists would have given useful advice (provided you had the sense to do the opposite of what they say).

Anyway, markets are volatile - that's why you can expect a long-run reward for equity market risk. Our Financial Analysts Journal article earlier this year shows that, over intervals of up to 60 years, many twentieth-century markets declined in real terms.

Btw, I have endorsed a new book on the South Sea Bubble called The First Crash: Lessons from the South Sea Bubble. Do read it. It's enchanting.