In my feature article for the August 22nd issue on the S&P downgrade of U.S. debt, I quoted market-watchers who warned that advisors' investment recommendations can no longer be guided by traditional "buy-and-hold" asset allocation strategies. Also to be employed is tactical asset allocation: the active adjusting of a portfolio mix of stocks, bonds, mutual funds or other securities so as to improve the risk-adjusted returns of passive management investing.
This point was amply reinforced by Ric Lager during an opening general session of the Society of Financial Service Professionals' Clinic for Advanced Professionals, held on August 16-17. Lager, a 401(k) plan advisor and president of Lager & Co. of Golden Valley, Minn., minced no words on the subject: Clients, he said, "can't afford to buy-and-hold in today's stock market" because of the potentially devastating losses their portfolios would suffer and the time required to recoup lost account values. I'm inclined to agree.
The buy-and-hold strategy propounds that, in the long run, financial markets give a good rate of return despite periods of volatility or decline. The strategy also stipulates that short-term market-timing–entering the market on the lows and selling on the highs–doesn't work. Attempting such timing yields negative results, so it is best for investors to simply buy and hold.
One argument for buy-and-hold is the efficient-market hypothesis: If every security is fairly valued at all times, then there is no point to trade. A second argument justifies the strategy on cost grounds, as brokerage fees are incurred on transactions. Buy-and-hold, the strategy's proponents say, involves the fewest transactions for a given amount invested in the market, all other things being equal.
Point noted. But such transaction costs pale in comparison to the potentially unrecoverable losses (at least for those in or close to retirement) that could result by not having a more nimble strategy. Lager underscored this point during the FSP general session.
From October 2007 through March 2009, Lager said, the S&P 500 Index fell 56% in value. Assuming that a 401(k) plan participant invested $500,000 in a S&P 500 Index fund that experienced such a decline, and thereafter enjoyed an annual 5% rate of return on the diminished account value ($220,000), then 17 years would pass before the full principal was restored (assuming the portfolio is adjusted for inflation, in 2008 dollars, and assuming contributions increase at the inflation rate).
Clearly, such a buy-and-hold strategy is dangerous. And thus Lager advocated using tactical asset allocation to stem losses at the start of a market dip. Specifically, the buying and selling of securities is determined by stock market "supply and demand" (chiefly the transactions of large institutions); and by the "relative strength," a measure for evaluating securities based on their historical price performance.
