What would you do if you found out that your entire approach to investing was wrong? This happens more often than you might think, so it's probably a good time to step back for a moment and consider the possibility that you are using an approach that doesn't make full use of your capabilities as an investor.

Think of it this way. Let's say you're an analytical type, and you're most comfortable crunching numbers and coming up with ways to do things more efficiently. Would it make sense for you to try to make a living as an artist? It's not that you couldn't succeed in that job, but it would be a struggle and you would probably not live up to your full potential as a productive member of society. 

Think about how many people are stuck in jobs that they don't enjoy because they're not naturally suited for that kind of work. It happens a lot, don't you think? Well, the same is true in investing. There are many ways to approach the job of managing your financial resources, and it's very easy to choose one that just doesn't suit you.

This usually happens when someone else shoehorns you into using an approach that they like, regardless of whether or not it's the best choice for who you are, how you think and make decisions, and so on. These mismatches are as common as dandelions in the spring, unfortunately.

In this series I will focus on the most heavily promoted approach in use today - Buy & Hold - and draw some conclusions about who should use it and who would be better off with something else.  

Here are some of the issues I'll be addressing:

Why do I describe the vaunted Buy & Hold (hereafter referred to as simply B-H) approach to managing your investments as a mythology? Because like all mythologies, it's based on a mixture of truth and folklore. It has widespread appeal because it requires little effort, especially when compared to more active approaches that require more frequent monitoring and adjustment.

With B-H, investors are told they can just "set it and forget it." For most people who are busy with work and family commitments, that's a powerful selling point. And that's the folklore part of the B-H mythology. The set-and-forget feature seems plausible - even intuitive perhaps - but in practice it's nearly impossible to pull off, and I'll explain why later on in this article. 

B-H is an approach that is marketed as a one-size-fits-all panacea for investors 

B-H is popular with investors because the industry promotes it, not because it's superior to other alternatives. It's not as easy to set up and manage as you might think. The idea of picking a handful of low-cost index funds and rebalancing the portfolio once per year sounds good, but there are very few people I have encountered who actually have the mental toughness and discipline to pull this off. It requires mental toughness to do nothing while the value of your life savings is declining month after month, sometimes for years at a time. It's not a natural way to invest.

What inevitably happens is that the B-H investor reaches a point of maximum discomfort during a major market decline and begins to sell off parts of the portfolio. This is a natural human response - to protect one's financial security when faced with a threat. B-H ignores this hard-wired human need for protection from financial ruin, whether it's real or imagined.

B-H is good for advisers, planners, and others who sell investment advice

One of the keys to effectively managing your money is the finite nature of time itself. Later on I'll go into the issue of time lost as a result of using a B-H approach, but for now I want to point out how the idea of finite time plays into the popularity of B-H with those who are selling it to clients. (I'll use "advisers" to include brokers, planners, fund managers, and anyone else who is on the selling end of the investment process.)

Advisers, like anyone else, only have 8 hours of productive time available. Naturally they want to make the best use of this time, and that means one thing - maximizing the amount of revenue they can squeeze out of each of those 8 hours. It's actually closer to 6 hours per day, with the other 2 hours spent on administrative tasks, product meetings, conferences, seminars, and so on. The point is that their time is very valuable and they don't want to waste a single minute of it. So what do they offer their clients when it comes to an investing approach? 

The main benefit of the B-H approach, from the advisers' perspective, is the minimum amount of time they must spend talking with, meeting with, hand-holding, and explaining things to their clients. The best client is one who only takes up 15 minutes of the adviser's time for end-of-year portfolio review and rebalancing. Why would an adviser even consider anything that  would take up more time than that? 

Does this mean that most advisers are doing a disservice to their clients? No, that's not what I'm saying. I'm just saying that B-H is the default approach for an adviser, and if the client demands something more active or complex, most advisers will do what the client wants. After all, they have a fiduciary duty to act in the client's best interest.

While I’m willing to grant that for some investors B-H is the best way to go, I take issue with the idea that it is universally superior to other, more nuanced approaches.

Evidence-based investing is the modern version of the passive, B-H approach. This relatively recent spin on an old idea comes from clever marketers who co-opted the work of academic researchers and put together an argument for the superiority of passive investing that was beyond reproach. It was evidence-based, they said. 

Aside from the annoyingly condescending implication that all other approaches are not evidence-based, and therefore must be based on pseudo-science or magical thinking, this is as much of a canard as the original B-H method. They gave it a fancy new name and have been promoting it far and wide to anyone who will listen.

Here are some of the claims that are made to promote evidence-based investing.

Every one of the above assertions are either false, misleading, or irrelevant. They are selling points that are part of a "Features & Benefits" pitch to unsuspecting investors. Once again, does this mean that B-H dressed up as evidence-based investing is a bad approach, or that those who promote it are scoundrels? No. For many investors, this is the best way to go. But not for all investors. 

Next time I'll begin to present evidence of my own to support my claim that B-H can be the wrong choice for investors, especially those who care about large draw downs in the value of their life savings. Here's a sample from part 2 of this series:

Large market drawdowns have permanent negative effects on an individual's progress toward reaching financial goals. This is why great money managers share one simple investment philosophy - "buy low, sell high." But hold on… how can you buy low and sell high if you’re always fully invested in the market? And what happens when you are forced to sell in order to raise needed funds when the market is in one of its bear phases?

See you next time.