Last week we closed out a tumultuous decade for the stock markets. The last ten years saw two major crashes separated by a terrific bull market and ended with a 50% gain in the last two years. The dramatic ups and downs caused successive waves of despair and exuberance. Some commentators, looking at the volatility, have declared that the age of “buy and hold” style investing has ended. We beg to differ.
In spite of the dramatic doings in the market an investor who bought the S&P/TSX composite index on Dec. 31, 2000 would have had an average gain of 7.08% per year for each of the past ten years. That is about twice as much as the average yield of bonds during the period, not even taking into account the lower tax rates for dividends and capital gains. Ten years is a pretty long time, but an investor who stuck with the market for only half as long also did pretty well. Here are the S&P/TSX composite index average yearly returns over five years for every five year period in the decade:
Starting in 2000 and ending in 2005 6.84% per year.
Starting in 2001 and ending in 2006 15.32% per year.
Starting in 2002 and ending in 2007 23.70% per year.
Starting in 2003 and ending in 2008 2.38% per year.
Starting in 2004 and ending in 2009 7.66% per year.
Starting in 2005 and ending in 2010 6.32% per year.
Note that even an investor who bailed out of the market at the worst possible time, at the end of 2008 following the worst stock market crash since the great depression, would still have made an average of 2.38% over each year of the five year period, a return comparable to that on bonds.
It is certainly true that an investor blessed with perfect foreknowledge of the direction that the markets would take would have done better to invest in 2002 following the bursting of the tech bubble and hold until 2007, cashing out with a stellar gain of over 23% per year on average. The same prescient investor would then have stayed out of the market until March 2009, and re-invested at the bottom that month, making an even more impressive 80% gain over the next twenty-one months. But in the real world, no one does that. In fact, quite the opposite happens.
What has been evident over this decade is that far too often the great majority of investors buy high and sell low. Following the 2008 crash the amount of cash in savings accounts, money market funds and low risk bonds grew to record highs and stayed at record highs even as the stock markets rebounded. Only in the past few months, after the TSX recovered by 6,000 points or 80% and after the S&P 500 rebounded by 600 points or 90%, have we seen significant movements of funds from safe haven investments back into equities. There is no way that investors who sold at the bottom and are buying now can match the returns of those who simply stayed in the market.
Successful market timing requires two great decisions: selling at or near the top, and buying at or near the bottom. It is very hard to get even one of these calls right. Getting both of them right has, over the history of the stock markets, proven to be all but impossible.
As we go into 2011, we are confronted by a world economy with a number of problems and challenges. That is the norm. Our job of finding, buying and holding high quality securities has not changed and neither has our investment style. The past decade has proven, just as have the decades before it, that buy and hold works, and that market timing is an impossible task.