Is Buy and Hold Dead? Performance Update.

June 2, 2009 by Joe Ponzio

I can’t believe that it has been nearly two years since F Wall Street was originally launched on June 25, 2007. And what a two years it has been!

Since our launch, we saw the S&P 500 climb to an all-time high in October of 2007, only to watch it plummet nearly 58% to a level first seen in May of 1996. Some of the causes of the drop were highly predictable. Some of the events, such as the September 2008 disaster, were completely unpredictable. And through it all, we were largely, if not entirely, invested in individual stocks.

Let’s see how we did.

Portfolio Performance

If you recall, I started the F Wall Street portfolio with $100,000, and compare it to the Diamond Trust Series (DIA) – an ETF that tracks the Dow – and the Vanguard S&P 500 index fund (VFINX). I compare to these two funds because investors can’t invest directly in an index; so, these are two of the broad “index-type” investments.

In the roughly two years since F Wall Street was launched, $100,000 in the F Wall Street portfolio grew to $103,224 (+3.2%) while $100,000 invested in the DIA and VFINX fell to $68,246 (-31.8%) and $63,225 (-36.8%), respectively. On an annualized basis, we have outperformed the better of the two investments (the DIA) by 19.6% per year.

What’s In Our Portfolio?

The portfolio snapshot below is as of yesterday’s close. This morning, I sold DBB because it didn’t work out as planned. I will discuss it in a later post.

Thoughts on Our Portfolio and Performance

Had I been able to spend more time and energy on the blog, I am certain that our results would have been much better. As the markets plummeted, I found myself with less and less time to post, as is indicated by my lack of activity here over the past year. I first mentioned this problem in March of 2008 in this post:

When the markets were flying high, I had all the time in the world to write posts for an hour or two a day. Trying to maintain that pace in this market would be detrimental to our future returns.

It is important to remember that I am not a professional blogger, living off advertising revenue and blogging for dollars. Nor am I a professional author, living off book royalties. (Trust me – there’s no money in writing books unless you’re Steven King.)

Some opportunities that were missed in the F Wall Street portfolio:

  • Graham Corporation, which was discussed ex post facto and never included in our results.
  • The InBev acquisition of Anheuser-Busch workout which, at one point, offered a substantial premium.
  • As I mentioned in this interview on First Business and back in November to my friend Barry Pasikov, Managing Partner at Hazelton Capital Partners, Sears Holding Company was an amazing opportunity in November, when it was trading at just $30 and less.
  • And, of course, Wells Fargo which, in February, fell to just $7.80 a share. In response to Dan’s question whether or not WFC was a screaming buy, I responded: “Screaming,” but didn’t have the time to post more about it.

These investments would have had a significant impact on our results. The total impact of these investments, as of June 1, 2009, would have added another 33% or so to our returns, broken down as follows:

  • about 2.5% from Graham, in which a 5% investment would have doubled,
  • about 0.5% from the InBev workout, in which a 10% investment would have grown about 5%,
  • 10% from Sears Holding Company, in which a 10% investment would have doubled, and
  • 20% from Wells Fargo, in which an additional 10% investment would have tripled.

And that’s net of some of my more boneheaded moves, like overpaying for American Eagle or getting my butt kicked in the Landry’s workout-gone-bad.

The point here is not that I’m backward looking or playing with the numbers, but that the market presented investors with some amazing opportunities over the past year, if, of course, you were looking at the business and not the media or stock markets.

On a relative basis, I’m bubbling over with joy at how we continue to outperform the markets and at the amount of safety our portfolio enjoys. On an absolute basis, I am upset that I didn’t have more time to discuss some of these amazing opportunities in greater detail and include them in the F Wall Street portfolio.

Still, we own some wonderful businesses at great prices. While my primary responsibility is to manage money for our clients, I will continue to run the F Wall Street portfolio on this part-time basis because, as I discuss in the book, casual investors can invest conservatively, confidently, and at satisfactory rates of return without taking a lot of risks. This portfolio will continue to be run “casually,” unlike the portfolios we manage at Ponzio Capital.

Thoughts on Diversification and Buy-and-Hold

Clearly, and once again proven over time, broad diversification just doesn’t cut it. Having extremely small positions (1% of the portfolio, or broadly diversified mutual funds) doesn’t allow your best ideas to have a meaningful impact on your returns. And though the losses have a greater impact (and we’ve had a few), a 5% loss in the portfolio due to a 50% loss on a 10% position is not impossible to overcome, so long as you can remove emotion and media hype from the equation and focus on making smart business decisions.

The number of positions an investor should hold is inversely correlated to the predictability and discount one receives in any investment. You could put your entire net worth into a single U.S. Government bond, and never diversify outside of that one bond because you have absolute certainty and predictability. Conversely, if you’re going to invest in a highly speculative, debt-laden, poorly run company, you wouldn’t want to risk too much of your savings.

That, of course, is one of the problems with mutual funds, and particularly index funds. Both the DIA and VFINX held General Motors as it fell from $90 to bankrupt and worthless over the past ten years. From a value standpoint, it was as worthless at $90 as it is today; however, if you have to own a GM (like when you invest in index funds), you certainly want it to be a very small portion of your portfolio.

This, of course, leads us to the constantly-asked-and-wrongly-answered question: Is buy-and-hold investing dead? The short answer is an emphatic “no.”

Whether stocks are rising, falling, or hanging flat, Wall Street wants you to believe that “it’s a trader’s market.” When the markets are rising, it’s a trader’s market because easy profits are aplenty. When the markets are falling, it’s a trader’s market because you need to be nimble and liquid. When the markets are flat, it’s a trader’s market because “buy and hold ain’t working” and you have to do something to make money.

The truth is that it’s always a trader’s market on Wall Street because Wall Street gets paid when you’re buying and selling. The broker handling the F Wall Street portfolio couldn’t buy an iPhone with the money he would have made from us.

Buy-and-hold is a poor strategy if you’re buying anything at any price, and holding it no matter what. If, however, you are buying great businesses at great prices, the overwhelming majority of active traders won’t be able to match your results over the long-term.

I had written the following to clients a few weeks back about this exact topic. Though it’s not an exact comparison, I think you’ll get the gist of it:

Warren Buffett has built his fortune on buy-and-hold investing. His company, Berkshire Hathaway, is not only larger than every brokerage firm in the United States (many of which are much older than Berkshire Hathaway), but it is larger than Goldman Sachs, Morgan Stanley, State Street, Citigroup, Charles Schwab, and E*TRADE combined. (Based on market capitalization at the close of business on May 7, 2009.)

A Final Thought, On Volatility

It’s easy to look at our results and think that the ride was smooth. All you see in the above chart is three points in time, and a straight line joining each of them. The truth is that the results were volatile, and we suffered wide swings in the prices of each of our investments.

There is no way to control the daily swings of the markets or any individual position. Then again, there is no need to worry about it if:

  1. You hold great investments at great prices, and
  2. You have no intention of selling that day.

When the markets pounded Wells Fargo down to $7.80 per share, we were down 67% from our initial purchase at $23.41. We invested again at $16.63, but that only gave us an even larger loss on a dollar-basis, and we were still down 63% in a matter of days.

It’s easy to sweat over the market action if you need to sell, or if you don’t fully understand your reason for buying. Even my own brother, whom will remain nameless but trusts me implicitly (I have four, so don’t try to guess), commented on the unrealized loss and was tempted to swear off stocks completely until we had more clarity in the markets.

The truth is that stock prices, on a daily, monthly, and even quarterly basis, are quite silly. Buffett and Munger commented on this at the annual meeting, I discuss it in detail here on the site and in the book, but I’ll reiterate it: A major key to the success of one’s investment program is having the right emotional make-up to handle the market’s ridiculousness.

As I stated in this post, most people don’t have the emotional constitution for investing in stocks. With the markets down nearly 40% from their October 2007 highs, people that were plowing money into stocks two years ago are now sitting on cash and looking for bonds. It’s not just individual investors – many pensions, mutual funds, and other institutions operate with this backwards mentality that investing should be done when prices are high and may go higher, instead of when prices are low, even if they go lower.

Over the long-term, the markets work very well; but, your investment results will depend on how much time you can put into your investing and how well you suppress your emotions while focusing on making smart business decisions.

The results of the F Wall Street portfolio will not do as well as I’d like going forward (that is, very high, non-conventionalist returns) due to my lack of time for blogging; so, I’ll focus on trying to make smart business decisions when I can post here.

(Of course, we’ll keep on trucking at the firm!)

A Note From Joe Ponzio

This section is for comments from F Wall Street visitors. Do not assume that Joe Ponzio agrees with or otherwise endorses any particular comment just because it appears or remains on this website.