Although finance experts frequently advocate buy and hold strategies, which involve the purchase and retention of stocks over long periods of time, certain market participants have challenged this approach and instead now advocate active investing strategies.
One finance academic who recently refuted the popularized suggestion of buy and hold is Andrew Lo, a finance professor at MIT Sloan School of Management. Lo challenged the efficient market hypothesis, which asserts that the current price of equities reflect all available information on the entities issuing them. This theory states that individuals who make efforts to beat the market through active investing will fail, and that efforts to buy stocks when their prices do not reflect their true value and sell them when they are inflated will not succeed.
In a recent interview with CNN Money, Lo stated that the idea of efficient markets is not entirely false, but should be updated to reflect the dynamics of a new market. He references his previously proposed adaptive market hypothesis, which states that economic entities including the stock market evolve over time in response to the actions of their participants.
The media outlet reports that due to this constantly changing market, millions of buyers and sellers are assessing the value of a security at any given time. During sharp swings in equities that coincide with bull and bear markets, investors who overreact with either too much greed or too much fear create asset values that are either artificially high or artificially low.
One example of these price trends is a bubble, when the normal mechanisms that prevent market participants from providing securities with valuations that are too high are overcome, resulting in inflated values. The constant increase in prices eventually becomes unsustainable, and the bubble bursts.
In addition to the adaptive market hypothesis explanation presented by Lo, other market experts have looked to historical evidence to support their view that buy and hold is no longer a valid strategy and that active investing is a viable option.
Forbes contributor Sy Harding's 1999 book "Riding the Bear: How to Prosper in the Coming Bear Market" noted that equities plunged 86 percent as a result of the stock market crash of 1929 and the subsequent price volatility, and that the market did not recover this wealth until 1955, according to the news source.
This timetable for recovery amounted to investors waiting 26 years to get their principal back. In 1965, the Dow Jones Industrial Average reached 1,000 for the first time, and did not hit this level again until 1982. For a total of 17 years, equities experienced cycles of bull markets and bear markets.
Harding said in the book that "buy-and-hold investing, for all its hype, and in spite of the apparent guarantee that history provides for the theory, just does not work. During the euphoria of a bull market it seems easy to picture oneself holding through a bear market, eagerly watching for it to end so the big gains will resume," according to the news source.
He added that "then comes the reality, the emotional and financial pain of watching hard earned assets disappearing 20, 30, 40 percent at a whack, the decline lasting for months, even a year or two, and thoroughly disillusioned buy and hold investors become market timers, but with the worst of timing, bailing out only after they have experienced huge losses."
Harding is not the only opponent of buy and hold to point to the severe volatility experienced by the stock market. Lo told CNN Money that a substantial fraction of the largest fluctuations experienced by the S&P happened within the last five or 10 years, which indicates that the contemporary market is "riskier."