Wait For The Fat Pitch: Buy And Hold Vs Active Management

Ted Williams described in his book, ‘The Science of Hitting,’ that the most important thing – for a hitter – is to wait for the right pitch. And that’s exactly the philosophy I have about investing – wait for the right pitch, and wait for the right deal. And it will come… It’s the key to investing.” – Warren Buffett

Many investment managers tempt investors with historical returns by using them as indicators of future return expectations. Unfortunately, even if they are clairvoyant, a buy and hold strategy based on a “known” long term return is likely not in a client’s best interest. Buy and hold strategies that are solely focused on a long-term total return fail to consider the current state of valuations, the risk reward profile, and therefore the path of returns the market may take between now and the future. Importantly, they also ignore investor circumstances and whether he or she is a young worker in savings mode or a retiree who must draw living expenses from their account.

Even with a “known” return, it may be comforting to think one can buy and hold without any reservations. The reality is that, in many circumstances, such a strategy leaves a lot to be desired. On the path between today and tomorrow, there will inevitably be periods where returns are well above original expectations accompanied by a lower level of risk. There will also be periods where returns are lower than expected and the risk is greater.

This paper is theoretical in nature, but the simple message underlying the article is, as stated in the opening quote, you do not have to swing at every pitch. Patience rewards the prudent.

Destination vs Path

Let’s take a time machine back to January 1st 2005. Given that we are coming from the future, we know the following facts about the S&P 500:

  • January 1, 2005 price: 1181.41
  • 2015 Cyclically-adjusted P/E (CAPE): 26.49
  • Earnings growth 2005-2015: 7.68%
  • Dividend yield 2005-2015: 2.04%:
  • Dec 31, 2015 price: 1524.53
  • Annualized total return 2005-2015: 7.59%
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