Chapter 10
Buy-Hold Myth #1: The Market Always Comes Back

Hang on to your investments, say the buy-holders. “Don't worry if your stocks drop. You're a long-term investor, and the market always comes back.”

The market always comes back? Who says it will? When will it? Let's ask the Japanese.

Back in the late 1980s, the Japanese were wealthy. They were buying all our golf courses. Everyone held up Japan as the preeminent economy. They said, “Wow, look how great Japan is doing. We should copy them.”

The Nikkei, Japan's stock market, peaked at 38,916 on December 29, 1989 (see Figure 10.1). It's never come back. It's still down about 64 percent from its apex in 1989. The Japanese stock market hasn't fully recovered, and it's been 25 years!

c10f001 — **Figure 10.1** Japan's Stock Market Peaked in 1989 and Is Still Down 25 Years Later

“Wait a minute, Ken,” you may say, “That's the Japanese. We're not Japan. We are the United States of America. That won't happen to us. We always find a way. American ingenuity can overcome all.”

Let me tell you a little story:

Orphan Annie was asleep in her bed when a noise woke her up. A shadowy figure stood over her dresser—doing what? Breaking into her piggy bank! Annie turned on her bedside lamp.

“Leapin' lizards!” she said. “Daddy Warbucks! You scared me half to death! What are you doing with my piggy bank?”

“I'm sorry, Annie,” said Daddy Warbucks, “but we just had a terrible stock market crash. All my money is tied up in the market. I just need a little bit of money to tide us over until the market comes back. I'll repay you then.”

“Sure thing,” said Annie, “When do you think that will be?”

“Soon,” said Daddy. “Surely 1930 will be a better year.”

Five years later, Annie woke up again. This time she recognized the figure breaking into her piggy back.

“Daddy Warbucks! What are you doing? You haven't repaid me from the last time you borrowed money.”

“I know, Annie. But we just need to wait a little longer. You know what they say during times like these…”

“The sun will come out tomorrow?”

“The market will always come back.”

“Okay,” said Annie, and went back to sleep.

Many years passed, and yet once again, Annie, was awoken by the sound of someone shaking coins out of her piggy bank. She flipped on the light.

“It's been over 20 years, Daddy! I thought you'd repay me ages ago.”

“Me, too, Annie.”

“I thought you said the market always comes back!”

“That's what everyone told me,” said Daddy Warbucks sadly, putting Annie's last nickel in his pocket.

Orphan Annie and Daddy Warbucks may be fictional characters, but the situation was real. In August of 1929, the Dow was at 380. Over the next three years, it went down to 54. That's an 86 percent drop! People who stayed in the market, people like our friend Daddy Warbucks, long-term investors who bought and held believing that “the market always comes back”—those folks saw 86 percent of their money vanish. No kidding.

“No need to worry,” the experts told them, “Keep the faith. The market will come back.” And sure enough, the market did come back. It did, dear reader. But do you know how long it took for the market to rise above 380 again? Twenty-five years (see Table 10.1). The market didn't come back until 1954, 25 years later. So, sure, the market may come back. But how many of you want to wait 25 years? And remember, if you are taking money out of your investments to live on, you may have depleted your savings. That money will never come back.

Table 10.1 Bear Markets since 1929 and the Years to Break Even

Bear Market Dates	Duration in Months	% Decline	Years to Break Even
9/1929–6/1932	33	–86	25
9/1932–2/1933	6	–41	1
7/1933–3/1935	20	–34	2
3/1937–3/1938	13	–60	9
11/1938–4/1942	42	–46	6
5/1946–6/1949	37	–30	4
8/1956–10/1957	15	–22	2
12/1961–6/1962	6	–28	2
2/1966–10/1966	8	–22	1
11/1968–5/1970	18	–36	3
1/1973–1/1974	21	–48	8
11/1980–8/1982	20	–27	2
8/1987–12/1987	3	–34	2
7/1990–10/1990	3	–20	1
3/2000–10/2002	31	–49	7
10/2007–3/2009	17	–57	6
Average	18	–40	5
Excluding 1929	17	–37	4

Source: S&P 500 Index prices obtained from Bloomberg.

Some Big Bad Bears

“But you are talking about the Great Depression,” you may say. “That happened just once in the history of our country.” You're right. That enormous drop happened once, and the wait for that particular rebound was the longest in our history. But we've had several devastating markets that took enormous lengths of time to bounce back. Let's look at some of the biggest baddest bear markets:

1973. The 1973 bear market lasted two years. The market dropped 48 percent. Investors lost almost half their money, and it took eight years to get back to even from that bear market.
1937. The market dropped 60 percent in 1937. The actual bear market lasted just a year, but it wasn't until 1946 before investors got back to even—nine years in all.
2000. I bet you'll remember this one: Y2K. This particular market also dropped 49 percent, but the bear lasted two and half years. Do you know how long it took for the market to come back to where it had been in 2000 before the drop? Seven years. It finally came back in 2007.
2007–2009. You'll recognize this bear, too: It began in 2007, continued through 2008 and went into 2009, lasting about one and a half years. That market drop was a 57 percenter, and it wasn't until 2013 that the market got back to its previous high—almost six years later. Interestingly, the market reached a value it hadn't seen since the year 2000. You could make the argument that it took 13 years to get back to even from the bear market of Y2K.
1929. As you recall, the granddaddy of all bear markets dropped 86 percent. This particularly bad market lasted about three years and investors had to wait 25 years to get back to even.

You may have noticed that two of the worst bear markets happened in recent memory. Does it appear to you that things are more volatile these days and risks are greater?

And let me ask you another question: Can you afford to risk even one of those bear markets? I may have listed some of the worst markets during the past hundred years, but consider this: Some floods happen only once in a hundred years, too. But if you're not ready for that hundred-year flood, it will wash you away.

Mini-Myth: If You Just Study Past Market History…

“But surely history is instructive!” you may say. “We can learn from our past mistakes.” Of course we can and we should. But unfortunately, people parlay this truth into a buy-hold mini-myth. “If we just study the past,” they say, “we can see that the market always comes back. It's much more consistent than people realize.” True, to a point. But it pays to be careful when looking backward.

Some financial experts apply their current strategies to past data. They say, “We've got this new strategy, and we can show you that if it had been used in the past, you would have had tremendous gains.” This method, called “backtesting” can yield interesting results. For example, several years ago, David Leinweber, the director of The Center for Innovative Financial Technology at Lawrence Berkeley National Lab, found a great predictor of the S&P 500's performance: butter production in Bangladesh. That's right, according to Leinweber's research, during the 10 years between 1983 and 1993, “when butter production was up 1 percent, the S&P 500 was up 2 percent the next year. Conversely, if butter production was down 10 percent, you could predict the S&P 500 would be down 20 percent.” Wow. Knowing that, you should dispense with all financial analysis and intelligent thought and use the butter production in Bangladesh index to predict what the market will do. I'm kidding, of course. That's ridiculous. Leinweber was not giving us a great new market indicator, he was pointing out that backtesting can be manipulated to “prove” nearly anything.

It's very easy to go back and find ways to create portfolios that might have worked in the past. In fact, let's do just that. Let's time travel back 10 years. I have the perfect strategy for you, one that would have made you 32 percent per year for the past 10 years. It's a simple portfolio, with only two investments: Treasury bills and Apple stock. In our scenario, all you have to do is watch Apple. Every time the stock hits a new all-time high, sell it. Put that money into treasuries so you can make some interest. Then once Apple stock drops 10 percent, buy it again. Now let's come back to the present day. Wasn't that a fantastic portfolio? If you had followed that strategy over the past 10 years, you would have made 32 percent per year. That's great, but so what? Does this mean Apple and treasuries will make you 32 percent over the next decade? Maybe, but then again, maybe not. The past doesn't dictate the future.

Mini-Myth: Time Is Your Friend

What was true in the past is not necessarily true in the present, either. “Time is your friend,” say the buy-holders. That was true when you were 18. But if you're retired or going to retire next year, time is no longer your friend—in fact, it's your enemy.

Remember, the buy-hold experts who write about time and investments aren't thinking about you, the retired investor. They're thinking about the market, in the long term…and I do mean long term. I recently read an article entitled “Portfolio Risk Appears to Diminish over Time.” In this article, the authors looked at years 1926 through 2010. That's 74 years. How many of you have 74 years to work with?

Why do the buy-hold people go back more than 70 years? Why don't they just talk about the past 10 or the past five years? Because if they did, it wouldn't satisfy their argument. The past decade has not been good. The Yale International Center for Finance reported that from 2000 through 2009, the average annual return for all stocks was a dismal –0.51 percent. Even the Great Depression was better: During the 1930s, the average annual return was –0.22 percent.

Homeland Security

Buy-holders may also argue that the past decade was anomalous, and that the market nearly always has positive returns over a 10-year period. That's fine if you're speaking in the abstract, but in the real world, if it happened once, it can happen again. And if you get caught in such an event, you can't decide to ignore it just because it's an anomaly. If you make a mistake, the penalty is severe. You can't afford to be wrong even once.

We have only had one September 11 tragedy, thank heavens. The odds of another airplane being flown into a building are really, really small, but Homeland Security still makes us take our shoes off and go through the detectors and take our laptops out of our bags. Why? Because they can't afford to allow even one more event to happen. They can't say, “There's only been one event like September 11 in our country's history, so let's ignore the whole thing. It's not going to happen again.” As a retired investor, you can't think that way, either. You need to be your own homeland security. You have to protect your investments as if they are your homeland. The fact that the market went up a hundred times in a row doesn't matter: What you need to worry about is the one time that is going to cost you.

Mini-Myth: The Most Successful Investors Stay in for the Long Run

Can you wait for the market to come back? Can you be a long-term investor? Simply put, I say “no.” When experts talk about “long-term investing,” most of them mean investment cycles of 30, 50, and even 70 years. They also assume that investors won't spend any of that money—that they'll leave it in their accounts, ride out the storm, and wait for the market to come back. Imagine a retired person saying, “Okay, I'll wait out the 2008 market. I'll wait six years before I touch any of my investments, because taking my money out now violates buy-hold, which everyone knows is the smart way to invest. So I'll leave my money in the market. I'm not going to touch it. I'm also not going to eat, drive my car, or pay my mortgage for four years. I'm going to wait for the market to turn around.” This is ridiculous, right? Only people with alternative sources of income can wait for the market to come around. If you're retired, that's not you.

Retired investors need to think about their time horizons. When I sit down with potential clients, the first thing I want to know is when they will need to access their money. The answer tells me that client's time horizon. Most retired people draw money out of their investments soon after they retire. They're not long-termers. If they make the mistake of thinking they are long-term investors, they often take more risk than they should. Let's say a retired investor decides she has a 20-year time horizon. The next month, bam! The market drops 30 percent. Uh oh. Any rational person knows that if you lose 30 percent of your money, you can't continue to spend at the same level. Our investor now needs to make a choice: slash her expenses by 30 percent, or recognize that the amount of time her money should last will be shortened dramatically. Not a pretty picture either way. It's very difficult to cut expenses by 30 percent. She'll either have to make huge changes in her lifestyle, or she will run out of money.

We're Not 25 Years Old Anymore

I do not climb ladders. I do not climb on the roof of my house. I do not climb trees. Why not? I have known too many middle-aged (or older) people who think they are still 25 years old. They climb up on their roofs to fix the gutters, and wind up falling and breaking something. I've learned from others' experiences (and a few of my own) that I'm no longer made of rubber and don't spring back the way I did when I was 25. I could break, and I might break in a way that would be permanent. It would be irresponsible for me to take that risk.

Risk is different when you're young. When you were 25, you probably didn't have a lot of money, so a 30 percent loss wouldn't change your life (and you would have had time to recoup that loss). Now, you've done a good job of saving your money and have built up enough to keep you comfortable in retirement. If you suffer a 30 percent loss today, you have broken something, and may have done irreparable damage.

I am not the same person I was at 25, and neither are you. We don't party the same way we did at 25. We don't dance the same way, play the same way, or travel the same way (YMCA, anyone?). We do very few things the same way at 55 that we did at 25. Why should investing be any different?

Where's the Contract?

Even if you are a 25-year-old investor reading this book (and if so, I congratulate you on your forward thinking), you should still be wary of the idea that markets always rebound to new highs. Where's the contract that says the market must come back? I've never seen it. I have seen the disclaimer on every investment sheet that shows any kind of return: “Past performance is not a guarantee of future results.” There's a reason why that statement is required to be on those documents: It's true. You cannot use the past to predict the future. The market does not have to come back.

Just ask the Japanese.