John Dough’s Investment Strategy
Buy and Hold
Back in the late 1990s, John Dough had it all figured out.
He had worked for the same government agency for more than 30 years, he made a nice salary, he would get a solid pension upon retirement, he was careful with his money, and he followed the tried-and-true investment strategy of none other than Warren Buffet:
“Buy a few good stocks and hold them forever.”
John Dough stayed away from the Dot Com stocks of the late 1990s. Instead, he had invested his portfolio in the ETF called SPY. This Exchange Traded Fund basically owns the stocks in the S&P 500 Index. And John knew that the S&P had yielded about an 8% annual return since 1957.1
His buy and hold strategy would enable him to sell 6% of his portfolio each year. With the historical record of the S&P, the amount of his estate would at least stay the same and perhaps even grow a few percent.
John hoped to sell his house in Arlington, VA, move to a smaller house in the country, and then buy a condo at the beach.
Oops … The Dot Com Crash of 2000
In the spring of 2000, everything fell apart.
Markets began to shake and then tumble.2 But John felt safe: his tried-and-true, buy and hold position in the S&P would surely protect him over time.
The S&P stood at 1494.50 on September 8, 2000.3 But it then dropped to the 800s in February 2003.4 John’s SPY investment got back to even briefly in 2007. Then it crashed again.
Finally, in the year 2013, John’s SPY buy and hold strategy got back to even.5
John had to work another 10 years. His wife had to get a job as well.
Beach condo? Not.
Buy and Hold If You Plan to Live Another 100 Years
John—and millions like him—fail to realize a key truth: yes, buy and hold if you plan to live to be 100 and you’re now 25. If you’re a pension fund that’ll be around forever, then perhaps a buy and hold strategy is right for you, too.
And if you’re Warren Buffet? Well, if you’ve got 50 billion stashed away for retirement, a 50% haircut won’t hurt. You’ve got 25 billion left over. You can afford to wait for the market to recover and for Mr. Bull to continue his journey.
But if you’ve got $400,000 stashed away, a 50% haircut can destroy your life.
Instead, Manage Risk Through Active Portfolio Management
If John had followed a different route in 2000, his life would be different. And a whole lot better. Instead of buying and holding the S&P, John should have sought to manage risk. He should have been in a position where he could get out in the spring of 2000 and take on some defensive positions.
What Is Risk Management?
Risk management analyzes the ebb and flow of the market. Using a variety of skills known as “technical analysis,” our financial advisors at Research Financial Advisors carefully monitor various moving averages to spot upcoming trouble in the market. If we get certain signals, we might decrease the holdings in a portfolio. If a serious signal waves the red flag, we might very well take on a “leveraged” position that goes up as the market goes down.
A COVID Example
When the virus struck in the spring of 2020, we started to play defense. We knew that a buy and hold strategy could wreck the retirement accounts of many of our clients. Instead, in February we started to exit our long positions, at one point going to 100% cash. We then began to purchase some leveraged “market short” positions—these are ETFs that go up in price when the market goes down. As the crash accelerated, these defensive positions prevented catastrophic losses.
As we watched our technical indicators (we watch a host of them every single day … all day), we began to see a slight shift in market temperament. Perhaps a bottom was approaching. So we began to take on some long positions that we thought might even thrive in this new, COVID economy. We bought some ETFs in the aerospace and defense sectors, in the home-gaming sector, and in the robotics sector.
Using technical analysis to manage our clients’ accounts, our 100% equity model ended 2020 with a 32% gain (net of fees). Meanwhile, the S&P advanced 15.76% in 2020.6 Even our 100% fixed income model clocked a gain of 8.5% (net of fees).
2020 Was Strange
Think about it. Millions of people out of work. Small businesses destroyed. Streets and sidewalks empty. No airplanes in the sky.
And the stock market goes up.
It could have crashed and turned into a 1930s nightmare.
Here Comes the Fed
In 2020, the Federal Reserve went on a bond-buying binge. Here’s what ordinarily happens when a bond is bought and sold. Suppose you have a $1,000 bond and you sell it to Susan. You give the bond to Susan, and she writes you a check for $1,000. Your account goes up $1,000. Susan’s goes down $1,000. The net effect on the money supply? Zero.
Now suppose the Federal Reserve buys your $1,000 bond. What happens then? Your account goes up $1,000. But nobody’s account goes down $1,000. The net effect on the money supply?
The money supply goes up $1,000 (with that increase in your account and no decrease in anyone else’s account).
Multiply that one thousand by one million and you get one billion. Multiply that one billion by one thousand and you get one trillion.
The Fed has increased the supply of dollars circulating throughout the globe by trillions. In fact, … are you sitting down …. as of last September nearly 25% of all dollars in existence were created in the past year.7
That Money Has to Do Something
That extra money needs a home. So it goes into housing. It goes into art work (a piece of crypto art recently sold for $69 million8). It goes into the stock market. That injection of cash saved us from a 1930s depression.
But what will the ultimate effect be? Inflation. Not just in homes and stocks and art. But also in bacon and eggs.
Risk Management Is the Best Approach
Buy and hold? Sure, if you’ve got a very long time horizon. But the buy and hold strategy of John Dough spelled trouble. Big trouble. The S&P began a long decline in the fall of 2000. John’s SPY holdings began to decline. Ultimately, his account took a 50% haircut. John had to wait 13 years before he was back to even.
Risk management would have saved his retirement.
Risk management. That’s what we do here with your account.
Give Us a Call
I invite you to call my office at 336-745-9726. I’m always happy to answer your questions about our approach.
We hope you’ll forward this email to your family, friends, and colleagues.
All my best,
J Thomas Knight, CFP®, CPA
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