Don't Give Up on Long-Term Investing

09/10/2009 12:30 pm EST

Focus: MARKETS

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, chairman of Schaeffer’s Investment Research, says too many people are abandoning “buy and hold” investing just when markets may be recovering.

While day traders made the headlines during the dot-com-driven bubble that ended so badly about a decade ago, this was actually the tail end of a golden era for the concept of long-term investing as exemplified by the “buy and hold” strategy, which was almost unquestioned as the key to investment success. Investors with five- or ten-year horizons were almost certain to be rewarded by their patience with handsome returns.

What a difference a subsequent decade of weak market returns has made! Ten-year stock market returns (excluding dividends) are now negative, with the Dow Jones Industrial Average currently down about 12% from its close in August 1999. These Dow ten-year returns first turned negative in November 2008, and there have been only 21 previous occurrences of negative decades since 1900 (based on signals being generated once over any 12-month period).

The most recent such negative period was for the decade ending in September 1982. [A recent Los Angeles Times] article cites examples of amateur investors diving into short-term trading with minimal experience or instruction, and one can hardly blame these people for their dissatisfaction with the stock market’s performance and their desire to do better for themselves.

But aside from the less-than-wonderful prognosis for inexperienced retail investors engaging in high-frequency trading, for the alert contrarian there may be a much more important message in all this: To wit, if one of the single worst decades in history for “buying and holding” in the stock market was preceded by near-universal acceptance of the buy-and-hold approach, might the widespread loss of faith in long-term investing now signal a very opportune time to engage in just such an activity?

This theory derives some modest comfort from what developed subsequent to the previous 21 negative decades, as the market was higher 70% of the time over the following one, three, and five years, and was higher 100% of the time over the following decade. And market returns over these periods were, on balance, better than average.

And then there was the famous BusinessWeek “Death of Equities” cover from August 1979, whose central premise was a complete loss of faith in the ability of the equity markets to provide consistent positive long-term returns, and which preceded by about two years the most significant stock market bottom of the modern era. Of course, two years can be a long time to wait for a market bottom, especially if this waiting period is punctuated by some major market slides.

It is a bit daunting to base your investment premise on a contrarian take on the fear and loathing of the crowd. But it certainly suggests that investors think long and hard before dismissing the stock market as a source of wealth over the next decade based upon the obvious shortcomings of the decade that just concluded.

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