STRATEGIES

STRATEGIES

Believe It or Not, 2 1/2 Years Is Not the Long Term

By MARK HULBE= RT

(Reprinted from the New York Times – August 4, 2= 002)

3DB BUY-AND-HOLD investing does not deserve to be any less popular today than it was several years ago. In fact, recent criticism of the strategy can be traced to a bas= ic misunderstanding of the concept.

The fundamental case for buyi= ng and holding stocks is — and has always been — based on historical trends. When measured over a long-enough period, stocks almost always go up. Unfortunately, few people appreciate just how l= ong the "long term" is.

Many investors have become disillusioned over the last two and a half years, as their stock holdings h= ave withered. Yet the market's recent losses fall easily within the confines of= what we could have expected.

Consider the record as it sto= od just before the start of this bear market: From the beginning of 1926 throu= gh 1999, the stock market had an annualized return of 11.3 percent, according = to Ibbotson Associates of Chicago, using the Standard & Poor's 500 since 1= 957 and the S.& P. 90 before that. Most importan= t, however, is the extent to which the market's annual performances have varied from that mean.

By checking the standard devi= ation, the most widely used statistical measure of that variab= ility, we know the market's historical returns fell within a surprisingly large ra= nge — from minus 8.7 percent to positive 31.3 percent — in about two-thirds of those 74 years. (To come up with that range, add or subtract = the standard deviation, 20 percent, from the 11.3 percent mean.)

The market losses in 2000 and= 2001 were just slightly below that range, so they should not have been shocking.=

How about losses for several = years in a row, as investors are now experiencing?

Again, the market's recent performance has not been outside the mainstream.

Consider research conducted i= n 1997 by Prof. Jeremy J. Siegel of the Wharton School of the University of Penns= ylvania and presented in his book, "Stocks for the Long Run" ( McGraw-Hill). Professor Siegel calculated the proportion of holding periods from 1802 to = 1996 in which the stock market failed to outperform a riskless investment: Treas= ury bills. For all the five-year holding periods over those 195 years, this proportion is 26.7 percent. That means that if you buy and hold stocks, and assuming the future is like the past, you have a better than a one-in-four chance of being worse off after five years than if you had invested in a mo= ney market fund instead.

So it should not be particula= rly surprising that stocks have failed to keep pace with 90-day Treasury bills = over the last five years.

How about 10-year holding per= iods? The numbers are hardly more reassuring: Stocks have failed to outperform T-bills 20.4 percent of the time. In fact, the only way to be more than 90 percent confident that buying and holding stocks will outperform T-bills is= to hold on for nearly 20 years.

These statistics, of course, = were widely available in the late 1990's. So why are so many erstwhile believers= in buy-and-hold investing so upset today?

Undoubtedly, they have myriad individual reasons. But most are symptoms of what psychologists call the be= lief in the "law of small numbers." Identified in the early 1970's by = two psychologists, Amos Tversky of Stanford and Daniel Kahnemann of Princeton, the concept applies to those who exagger= ate the extent to which a small sample represents the universe.

After several years of rising= stock prices in the late 1990's, for example, many investors started believing th= at the market goes up in almost all years. Not surprisingly, buy-and-hold strategies became the rage.

But now, with the market in a= third year of losses, some investors are going to the other extreme, doubting whe= ther the market can ever go up. This explains why buy-and-hold is now so out of favor.

Neither extreme is helpful. As recent experience illustrates, buy-and-hold strategies are not for the fain= t of heart. If two and a half years of losses are enough to make you retreat, you don't have what it takes.