Peter Lynch: Why Buy-And-Hold Investing Beats Market Timing

Check out this gem from page 23 of Peter Lynch’s classic “One Up On Wall Street” that explains the wisdom of always staying fully invested: “If you put $100,000 in stocks on July 1, 1994, and stayed fully invested for five years, your $100,000 grew into $341,722. But if you were out of stocks for just thirty days over that stretch—the thirty days when stocks had their biggest gains—your $100,000 turned into a disappointing $153,792. By staying in the market, you more than doubled your reward.”

That’s why I can’t really relate to people who want to sell Johnson & Johnson at $92 and repurchase it at $80, or sell Coca-Cola at $40 and repurchase it at $35, or sell Exxon at $100 and repurchase it at $85. We have to get past our natural tendencies to think linearly and keep in mind that stock prices tend to move in fits and starts, rather than a constant slow-moving slope upward.

Think of it like this: in a good year between 1926 and 2006, the Dow Jones advanced about 10% on average in a given year. There have been seven days in American history when you have gotten more than a year’s worth of return on a single day. On March 15th, 1933, the Dow Jones went up 15.34%. On October 6th, 1931, it went up 14.87%. On the day before Halloween in 1929, the Dow Jones saw a 12.34%. On September 21st, 1932, the Dow shot up 11.36%. And then there are the more recent examples: on October 13th, 2008, the Dow advanced 11.08%. Two weeks later on October 28th, the Dow went up 10.88%. And, then, on October 21st, 1987, the Dow increased 10.15%. On a percentage point basis, those days alone covered my ground than entire years.

A 10% long-term annual gain is not achieved at a steady clip of 0.83% per month. The best days tend to be concentrated as the Lynch example above demonstrated. That’s why market timing doesn’t work. No one rings on a bell on the morning of October 28th, 2008 to tell you, “Hey, you better be in the stock market today, because it is going to go up more than 10%.”  That’s why buy-and-hold investing is an important advantage over a market timing strategy: the best days in the stock market’s history have come in concentrated spurts that even in hindsight does not reveal a predictive pattern, and it can be weird for people to appreciate the fact that almost 80% of the stock market’s gains from 1926 through 2006 have come from 426 days of stock market trading. Almost a century boiled down to a little more than a calendar year.

Originally posted 2014-01-07 04:05:10.

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4 thoughts on “Peter Lynch: Why Buy-And-Hold Investing Beats Market Timing

  1. scchan_2009 says:

    There are many reasons against market timing:

    1) Rarely anyone can do that with any skill

    2) Trading a lot increase your trading cost

    3) Short term capital gains are taxed at a higher rate than long term capital gains.

    While 1 is purely a "skill issue" (can the market be timed? no, you can't), but 2 and 3 are cost. Money paid to IRS and your broker are lost income forever! It is for the same argument that low cost index funds are preferable over more expensive funds – money taken by the fund manager is lost income for yourself forever.

    It isn't just Lynch that said market timing is futile. Warren said that, Graham said that. Zweig who writes the commentary for the published version of the Intelligent Investor actually had also multiple worked out examples why market timing and over-trading do not work.

    As a bit of criticism to myself, I have done that a few times of myself and had kicked myself by doing that. I am not going back there.

  2. wes_was_here says:

    Great thoughts. I wonder the older folks (myself included) with substantial mutual funds in company retirement plans – if there is merit in selling to a cash fund after a 30% up year and systematically reinvesting the cash fund into the markets over the next 2-3 years with regular, automatic buybacks. There are no transaction costs, but there could be some opportunity loss.  Odds are their "profits" would be able to buy back into the markets at a lower cost.Thoughts?

  3. says:

    wes_was_here It's difficult to say. How many people saw stocks in the S&P 500 shooting up around 30% this year past year? Would you be kicking yourself if you were holding cash and you saw stocks climb another 20%? That's the problem with that underlying game. Instead, I'd ask this: Are you comfortable with the way that the mutual funds you hold are invested? Although I poke fun at mutual funds on occasion, it's not as if they are de facto bad things to hold. Dodge & Cox, Tweedy Browne, Sequoia, Yacktman–there's a lot of good managers running mutual funds out there (there's also a lot of bad). Take a look at what they own, the fees they change, and the tax consequences of getting out of them. If you are paying 2% annually to own low-quality securities, that might be something you want to get out of quickly, take your tax bite, and move on. 

    On the other hand, if you've been holding the Yacktman Fund for fifteen years, I'd be hesitant to pay a lot in taxes to get out of a fund with high-quality assets and reasonable fees. 

    I'm my case, I like to fix "mistake" holdings quickly, and own things I understand without paying anyone an asset override (i.e. an ongoing fee), and while I have no problem with the philosophy of holding cash, I'm less convinced of the wisdom to turn assets into cash and try to market time opportunistically. On the other hand, this might be a more sensible strategy now than it would be in 2009 to 2010 given the relentless forward shifts in the valuations of a lot of stocks, but that is only a decision you can make.

    In short, here's what I would do: if something is high in fees and not particularly spectacular in terms of portfolio holdings, I'd get out of it quick and put it into the likes of Royal Dutch Shell, BP, Coca-Cola, Johnson & Johnson, and General Mills. If I had a large unrealized taxable gain and the fees weren't that high (I define high fees as something over 1.25% for a domestic large-cap mutual fund, for the purpose of this conversation), then I'd probably keep the funds as is and slowly shift out of it by taking the distributions and dividends from it and investing them elsewhere. But without knowing the details of the fund, your goals, and your general temperament and investing style, I can't really answer your question.

  4. wes_was_here says:

    TimMcAleenan wes_was_here  I appreciate the response. To clarify: these are 401(k) or 403(b) retirement funds, generally restricted to invest in fund families, and (my) fees are under 0.25%, and (as I understand) incur no transaction costs or tax consequences to transfer between equity funds and treasury or money market funds.

    So, it seems one could take tax-free, zero transaction-cost profits, and then, with 10-15 of earning years left in my case, systematically buy back into equities. It's like doubling up on my regular monthly contributions. Yes, if 2014 sees 20%, you lose, but then you are buying into it. This dilutes future profits, but insures against heavy potential losses which seems a valid goal as one approaches retirement. (I am 58ish.)

    I will reconsider this concept as a portfolio-balancing technique opposed to a market timing strategy, essentially moving equity profits into fixed income after large markets gains rather than buying into a balanced product (which I have never cared for in younger days).

    I look forward to reading more of your thoughts as I also find myself training three young adults to do something most their peers never do – save and invest.  Absolutely love the reference to the "greater than annual than annual return" days!  🙂

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