Is Buy-And-Hold Dead?

By Greg Rodger on June 17, 2010

Not according to Dr. Burton Malkiel, one of the true legends of the Investment Industry.

Last night my colleague John Platt and I had the distinct pleasure of spending an evening with, Dr. Malkiel and a small group of investment professionals.  Dr. Malkiel is an author of numerous investment books including the classic “A Random Walk Down Wall Street”, which was first published in 1973 and is currently in its ninth edition.

In addition to being a noted author, Dr. Malkiel holds the Chemical Bank Chairman’s Professorship in Economics at Princeton University and is a former member of the President’s Council of Economic Advisors.

At 77 years of age, Dr. Malkiel shows no signs of slowing down and remains extremely sharp and committed to his belief that the average investor should invest in index funds and hold them for the long term.  The basic premise that he has been espousing for decades is that the movement of a stock’s price on any given day is a random event and cannot be predicted with any kind of certainty and certainly not with consistency.  For this reason he is not a fan of active management or trying to time the market.  He also is a staunch believer (as are we at HighView) in the need to have a disciplined process for portfolio rebalancing.  Rebalancing is an area that Dr. Malkiel has done a tremendous amount of research on.  His findings conclude that the primary benefit of regular rebalancing is that of risk reduction. It may also help with returns, but it is risk reduction that is the primary reason to rebalance in his view.  His preferred method of rebalancing is to have a fixed date, once every 12 months, when the portfolio is rebalanced back to its target mix.  Rebalancing more often incurs too many transactions costs and can be inefficient on an after-tax basis.  When I pressed him on this issue he agreed that having a pre-determined and disciplined range around your target allocation which triggers a rebalance can also be an effective method.

With respect to those who have come out strongly against the Efficient Market Hypothesis since the market meltdown, he simply says they are wrong.  He remains of the belief that investors acted more-or-less rationally all through the meltdown (and its subsequent recovery) given the information they had at the time.  However, Malkiel is on record as saying (and he reiterated it last night) that the markets are not totally efficient.  As a result he feels it is appropriate to hold index funds as the core of a portfolio and to employ active management around it.  In fact, he admitted that with his own portfolio he employs this approach.  Surprisingly, he also admitted to doing some stock picking within his own portfolio.  On this point, however he confessed that he doesn’t do it because he thinks it will outperform his core indexed portfolio, but rather he does it because “it’s fun”.

You Get What You Don’t Pay For

Dr. Malkiel reiterated a famous quote from Jack Bogle, “you get what you don’t pay for” referring to the importance of keeping costs low (i.e. low MER’s on funds).  It’s no surprise that he is not a fan of high-cost mutual funds (both due to cost and his lack of belief in the benefits of active management).  As one might suspect, he is also not a big fan of hedge funds.  He suggests that while some of the data may look intriguing, it typically suffers from significant survivorship bias as a great number of funds close down each year.

Like many economists, Dr. Malkiel is very concerned about the high levels of government debts and deficits in the developed economies.  He is not certain how it will work itself out, but does believe that there is a good chance that Greece and some other countries in Europe will eventually default on their debt as he can see no other way out for them.  With respect to the United States, he is concerned that they may have to inflate their way out of the debt problem (i.e. very high inflation), but that is likely many years down the road, and there are other options that he hopes U.S. officials adopt.

I should acknowledge that last night’s dinner was sponsored by Vanguard, by assets, the global leader in low-cost funds.  Given that my dinner was complimentary and I gained some great insight into the current thinking of an investment legend, I guess you could say that I definitely got what I didn’t pay for.

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