Bill Gross and the Case for Buy Low and Hold
Bill Gross, head of bond giant PIMCO, made news earlier this year by getting out of U.S. Treasuries.
The end of the Fed's quantitative easing, he reckoned, was going to be bad for bonds. Prices would fall, yields would rise.
Whoops. The opposite happened. Yields plunged. After Treasuries were downgraded by Standard & Poor's this month, they posted some of their best days in history.
Bad news for Gross, whose funds have lagged heavily against benchmarks.
He admits his folly, telling TheWall Street Journal the move was a "mistake," and that "we try to be very intellectually honest and honest with the public."
Hey, mistakes happen -- and it's even better when you admit them. But then there's this, from the Journal:
"The Total Return Fund has been adding to its Treasury positions since March, including a jump in July to 10% of its holdings, up from 8% in June. Overall, the fund now has net positive exposure to Treasurys for the first time in months."
When 10-year Treasuries yielded 3.5%, Gross was a major seller. Now that they yield closer to 2%, he's a major buyer. This wasn't investing. It was an attempt at market timing gone astray -- and it cost his investors big.
This happens more often than you might think -- and more often than it should. As the finance blog The Capital Spectator wrote of Gross' moves yesterday:
"To be fair, Gross enjoys one of the best records among fixed-income managers, even after his 'mistake.' But his ill-timed bet is a reminder that even the smartest of money men can and will stumble at times. The only question is how big the stumble will be? ...
"In order to beat the benchmark, you have to move away from it. It's also true that for those who mint market-beating results, the advantage is financed exclusively by those who made losing bets. In the middle, as always, is the benchmark. And after adjusting for the relatively higher expense of active management, the benchmark is likely to end up as slightly above average. That's true for individual asset classes and for multi-asset class portfolios as well.
"Skeptical? You're not alone. The majority of the planet's investors subscribe to the idea that great success awaits in active management. Nonetheless, you can safely anticipate that half of those who attempt to outguess Mr. Market will end up with below-average results."
Not coincidentally, multiple studies confirm that those who trade the most perform the worst. In his book Enough, Vanguard founder John Bogle writes of "the relentless rules of humble arithmetic":
"The gross return generated in the financial markets, minus the cost of the financial system, equals the net return actually delivered to investors.
"Thus, as long as our financial system delivers to our investors in the aggregate whatever returns our stock and bond markets are generous enough to deliver, but only after the cost of financial intermediation are deducted, the ability of our citizens to accumulate savings for retirement will continue to be seriously undermined by the enormous costs of the system."
Most investors could improve their returns by pounding these simple rules into their heads. Trade more, earn less.
In past lifetimes, these rules were followed with a case for buy and hold. If you can't outwit the market, just be the market. Buy stocks. Hold them for a long time. Enjoy the beach in between.
But things get itchy during a multiyear sideways market cycle like we're in now. When the benchmark returns zero (or less), the desperation to beat it grows exponentially. Even companies whose earnings have grown mightily have seen their stocks languish: Microsoft (NAS: MSFT) , Wal-Mart (NYS: WMT) , Google (NAS: GOOG) , and Johnson & Johnson (NYS: JNJ) all fit that bill. That's the struggle of a market where P/E ratios are compressing. And it gives people the sense that they need to trade more to get ahead, which reduces their odds of success even more. It's a world full of frustration and ironies.
But I think there's a happy medium. I'd call it buy low and hold. It goes something like this:
- Like an active investor, you only buy at what you perceive as opportune times, such as when investments trade below long-term average valuations.
- Unlike an active investor, your selling plans are primarily influenced by a long-term target goal: retirement, kids' school, etc.
- Like a buy-and-hold investor, you couldn't care less about what happens in the short run. There are no "whoops, that was a mistake -- let's sell and try again" moments.
The most important variable in any investment is the starting price. In bull markets, you can get away with flubbing that price since the general trend is up. In sideways markets like today, there's no room for error -- nailing that starting price is vital. There's still no excuse for excessive trading. But one can combine the passivity of a buy-and-hold investor with the opportunism of an active investor by buying only when things are plainly cheap and waiting patiently thereafter, regardless of volatility.
This is painfully oversimplified. But so much of what sends investors astray are painfully simple mistakes. Every investor could improve their results by keeping a buy-low-and-hold mentality in mind. Even masters like Gross, it appears.
Fool contributorMorgan Houselowns shares of Microsoft, Wal-Mart, and Johnson & Johnson. Follow him on Twitter @TMFHousel.The Motley Fool owns shares of Microsoft, Wal-Mart Stores, Johnson & Johnson, and Google. Motley Fool newsletter services have recommended buying shares of Google, Wal-Mart Stores, Microsoft, and Johnson & Johnson. They have also recommended creating a bull call spread position in Microsoft and a diagonal call position in Johnson & Johnson and Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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