The so-called experts from the financial services industry say that what we do in our investing system can’t be done. They base this opinion on the findings related to an investment strategy called market timing.
Market timing has proved to be impossible for anyone that has ever attempted it. We totally agree with that assessment. Market timing means that the investor attempts to sell at every market peak and buy at every market bottom. The stock market is too volatile and unpredictable for anyone to succeed with this approach.
These “experts” are confusing what we do with market timing. We don’t attempt to sell at tops and buy at bottoms. Our model is only on the lookout for one thing: the dreaded bear market. We don’t attempt to trade minor market corrections of 10%, for example. Because markets are so volatile and unpredictable, there’s simply not enough of a spread in a 10% correction to get out near the top and to get back in near the bottom. Our system is not that good. Nobody’s system is that good.
We simply look out for major bear market corrections, where the stock market falls by 37% on average but often as much as 50% or more. There’s a large enough spread in those market drops and subsequent recoveries to “trade the crash.”
Look at the charts for the S&P 500 in both the 2000 dot-com crash and the 2008 financial crash. Between 2000 and 2002, the S&P 500 dropped by 48%. That drop is highlighted in the graph. We knew there had to be a way to attempt to trade a huge spread like 48% to outperform the “Buy & Hold” gold standard. One does not need to be perfect or even that good to profit off this kind of volatility.
The 2008 financial collapse was even more dramatic, with the S&P 500 falling by more than 55% in less than 18 months. There’s a lot of room for error in attempting to trade a 55% move.
Our model is 100% focused on getting out as early as possible when the risk of a major bear market decline is imminent. On the flip side, our model includes another set of algorithms to get back in as early as possible when markets inevitably recover, as they did in both 2003 and 2009 (see charts above).
And because we’re continuously protected by our algorithms against a collapse, we can go “all in” when our model flashes a signal of low risk. There’s no reason not to invest aggressively when you’re protected against big losses. We’re also very comfortable going “all in” on the market when risk is low, because the long-term direction of the market is always higher.
It would take a complete breakdown of our political and economic system for the long-term direction of the stock market to be negative. And if that ever happens, every investing method except ours would be in trouble. In that extreme situation, the BB&H system would get out of the market before the worst of the damage is done. It’s the only strategy that protects your money in this way.
We’re no better at predicting the short-term direction of the stock market than anyone else. We don’t even attempt to predict short-term trends. We simply react to the risk assessments of our model based on what is happening in the markets. Bear market collapses typically last a long time—roughly 11 months from peak to trough. Markets tend to move gradually downward and gradually upward. There’s plenty of time to read and react to these trends and price moves.
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The primary argument that the financial services industry uses to encourage people to “Buy and Hold” is the ten best days theory. This argument states that if an investor misses the ten best days in a decade that they will see their returns for the entire decade cut in half. The industry backs up this argument with real data and compelling charts. It must be true, right?
Here is an actual analysis of the ten best days theory that I pulled from a website of a major national investment firm.
This firm analyzed the performance of the stock market over the two-decade time period between January of 2000 and December of 2019. They compared the actual performance of the stock market over that period to what the results would have been if an investor kept their money in the market the entire time except for the ten best days during those twenty years.
The sum of the daily returns for the ten best days during this time was 69% - or an average of a positive 6.9% per day. Removing the gains of those ten days cut the investment returns in half for the two-decade period. Simply missing ten days of investing would have cost you half of your money. Amazing, right? Their conclusion is that everyone must stay invested in the stock market at all times so that you don’t miss the ten best days. All the major firms publish their own research papers making the exact same case.
Many of you are probably already smelling something fishy here. When you step back from what they are saying and look at the argument objectively, the whole thing is pretty ridiculous. It is very easy to uncover the flaws in this argument.
First, why don’t they do the same analysis of the ten worst days for the same time period? Guess what the sum of the daily returns were for the ten worst days during the same period used in the previous analysis? The answer is a minus 68%. The losses for the ten worst days (-68%) exactly offset the gains from the best ten days (+69%). Isn’t it interesting that they don’t mention this in their studies? Are we to believe that no one at any of these firms over the last 50 years has ever thought to compare the ten best days to the ten worst days? Am I the only one to do this or are they just conveniently leaving this out?
Their argument might still work if the ten best days and the ten worst days were in different time periods. If the ten best days were all in the same month, for example, you would definitely want to be fully invested in the market during that month. But on the flip side, if the ten worst days were all in the same month, you would definitely want to avoid investing during that month. What does the data say?
As you probably already guessed, markets are very erratic. Big up days are often followed or preceded by big down days. Markets very rarely move straight up or straight down.
Look at the following chart for the fall of 2008. It so happens that five of the ten best days in the twenty-year time period from the previous analysis occurred in the fall of 2008. The fact that five of the ten best days occurred in the middle of one of the worst market crashes in history already tells you most of what you need to know. The scatter plot below reveals that eight of the worst ten days of this time period also occurred in the fall of 2008. The five dots in the top half of the chart (positive returns) represent the best days and the eight dots in the bottom half of the chart (negative returns) represent the worst days.
If the ten best days argument leads to the conclusion that we should always stay invested in the market, then what about the fall of 2008? Did it make sense to stay fully invested in the fall of 2008 to reap the benefits of those five terrific days even though the market was collapsing over the same time period? The people who promote the ten best days theory don’t want you to see this chart.
Clearly, the ten best days theory is a foolish argument. It only makes sense if they are telling people not to day-trade the market. Nobody day-trades the market. Most people know that day trading is dumb. Ignore the ten best days argument. In fact, avoid working with anyone that makes this silly argument.
Happy Investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
When you invest in the stock market through an index fund representing the S&P 500, you can be extremely confident that the value of that investment will grow significantly in the long term. You can be much more confident in the value of your stock market investment increasing than you can be in the value of commodities or real estate increasing in the long term. You can be much more confident in the value of the S&P 500 increasing than you can be of the value of any specific individual stock. Why is that necessarily true?
When we refer to the “stock market” in this article, we are referring to the S&P 500 – the index that represents the 500 largest and best companies in the world. We are not referring to individual stocks or specific mutual funds or sector funds. The S&P 500 is the best representation of the broad stock market because of its size and its diversity.
The first factor to consider is the history of asset prices. The stock market has delivered higher investment gains than all other asset classes over long periods of time (30 years or more). The S&P 500 has returned between 9% and 10% per year over the last 50 years when you include dividends. Dividend payouts are lower now than they were in the past so future expectations should be closer to 9% than to 10%, but that is still a very good return. Bond yields have averaged between 5% and 6% per year for the last several decades, but I would expect bonds to pay only 4% to 5% per year in the future. No commodity has consistently returned anywhere near 10% per year over the past several decades.
But as we are often told, past performance is no guarantee of future results, right? How can we be so sure of the gains from the stock market in the future? What do stocks have going for them compared to the other asset classes?
Our entire political and socio-economic system is designed for the companies in the stock market to succeed. Let’s look at the incentives that help to propel the stock market higher:
All 500 companies in the S&P index have tremendous incentives to grow. The management, the board members, the shareholders, and the employees have huge incentives in place for those companies to be successful.
Local, state, and national governments are incentivized for those companies to grow. Tax revenues and job opportunities benefit all government entities.
The general population (voters) wants good paying jobs in their communities.
Investment capital flows to growing and successful companies.
While the same incentives are there for individual companies to succeed, the same argument doesn’t hold up when we are talking about the stocks of individual companies. Diversification allows us to be extremely confident in the S&P 500. In any year or any time period, we see a mix of company performance and stock performance within the 500 companies in the S&P index. The growth of the market in any period is typically driven by only about 25% of the companies in the index. That means that 75% of the companies in the S&P 500 index typically underperform the market average. And in different time periods, we see different companies driving the growth. Looking out 30 years or more, history suggests that half the companies in the S&P 500 will not be around. No one can be certain about which companies will survive and which one will not.
The S&P 500 contains companies from all the biggest and most important sectors of our economy. The index has a nice mix of financial companies, industrial companies, technology companies, consumer goods companies, health care companies, pharmaceutical companies, etc. When one major sector struggles there is typically another sector that performs very well. When you own an index fund representing the S&P 500, you get both individual company diversification and you get industry sector diversification.
The same incentives that drive the stock market are not in place for bonds, or commodities, or real estate. Most people would prefer that the price of commodities and real estate remain constant or even go down. Consumers and governments don’t like price increases. Look no further than the inflation challenges we face right now. Most people would prefer that interest rates on bonds were lower rather than higher. Higher rates limit borrowing which inhibits growth in the economy. There are plenty of people who benefit when prices increase but they are in the minority.
The market seems to be very comfortable with bond rates around 4% to 5% over the long term. Investors are comfortable with this return rate for the level of risk associated with bonds. Since there is much higher risk associated with stock investments, investors seem to be comfortable with stock market returns being roughly double the returns of bonds (stock returns of 8% to 10% vs. bond returns of 4% to 5%). If stock returns get too close to bond returns, there is no incentive to invest in stocks.
The other factor to consider is innovation. It is innovation and productivity that drive the increase in value in companies and, therefore, the stock market. We have created a highly innovative and productive economy and I see no reason for that to slow down in the future. One could argue that innovation is accelerating rather than slowing down.
The only thing that could get in the way of the 8% to 9% continued annual growth of the stock market is a collapse of our political system. Given the events of the last five years, one can’t totally rule that out. But even in the most extreme situation of political upheaval, the same incentives for market growth will still be in place. There is way too much money at stake. Major political disruption would have a big, short-term effect on the stock market but after a period of time, the stock market will continue growing.
Our Beyond Buy & Hold system protects investors from major, short-term collapses regardless of the reason. Everyone needs an investing strategy like our Beyond Buy & Hold system to protect against the inevitable, short-term disruptions to the stock market. People need a better approach than simply “Riding it Out”.
The best investment strategy for long term growth is built upon investments in index funds representing the S&P 500 and the Nasdaq. Our entire political and economic system is designed to support the healthy growth of the stock market. You can be extremely confident in achieving long-term returns 8% to 9% per year even accounting for short-term bear market collapse like the one we are going through right now. Combining a market index investing strategy with a risk-based trading strategy like our Beyond Buy & Hold system will get you even higher returns.
Happy investing,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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