Buy and hold investing may not be particularly exciting, but the benefits are undeniable.

My longest-term holding is ADP (NAS: ADP), the American provider of human resources management software and services. The original buy was in 1981 when I was coming into my prime as a two-year-old investor. Clearly this was not my decision.

My wife’s father invested a small amount in ADP for her. Despite not being able to take credit for this purchase it is still illustrative of the power of compounding over long holding periods.

The cost basis on the position is $1.50. The current annualised dividend is $5.60 a share. I am confident the dividend will keep getting raised. This confidence is basd on the fact that ADP has raised their dividend for 49 years in a row. And there has been a bit of price appreciation as well. ADP is currently trading at $263. That is a 18,177% return.

The source of that return has to do with picking the right company. But it also has to do with discipline. ADP fell more than 48% during the tech bubble crash in 2000. It fell 30% during the GFC.

As a company whose fortunes are tied to the number of people employed it suffers during economic downturns. I could have made a credible argument during both recessions that it made sense to rotate into a company with less exposure to the economic cycle. Lots of other investors followed that rationale which accounts for the large drops in price. That would have been the wrong decision.       

This is not to say that there is never a reason to trade. But your default should be doing nothing. A well diversified portfolio held over the long-term puts you in the best position to achieve your investing goals. It puts you in the best position to achieve the higher expected long-term returns we get for riding out short-term volatility.

Easier said than done

As a product of the American education system I was presented with a copy of The Catcher in the Rye in sixth grade like my peers across the country. The first time I read it was not the last. And I’m sure it will find its way into my hands again.

The overriding theme of the book is hypocrisy. The narrator went by the name of Holden Caulfield and he loved pointing out the phoniness of adults. He was consumed by it. Holden would have had a field day with investors.

There is no better example of investor hypocrisy than the lip service paid to long-term investing. There is universal acknowledgement of the benefits of long-term investing and frequent proselytising to that effect from professional investors. Yet the data doesn’t hold up.

A study showed that the average turnover ratio for US domestic equity funds was 63% in 2019. That means that every year more than half of the positions are new. And it isn’t just professional managers who can’t practice what they preach.

In June of 2020 the average holding period of a share trading on the NYSE was 5 ½ months. This was down from 14 months in 2019. The average holding period has been dropping for decades after reaching a high of close to 8 years in the mid-1960s.

There is no single reason for this but undoubtably the removal of friction to trade is playing a role. Executing a trade used to involve a call to a broker. At the very least this would give your broker the opportunity to talk you out of doing something against your best interest. Today we can trade with a couple clicks on our phones without any human interaction.

There is a powerful psychological impact associated with anonymity. We navigate between two different versions of ourselves. Our public self is the version that the world sees and involves a concerted effort to portray ourselves in ways that adhere to societal norms. Our public self is committed to the Buffett maxim that the best holding period is forever. Then there is our private self. These are the behaviours that we keep hidden because we know they are not in our best interest or reflect poorly on us. Your private self is absent-mindedly trading on your phone on the way to lunch.

If you want to be a better investor it is time to devise a system to counteract the lure inherent in the anonymity of trading. Put more friction into investing. Find a mate to talk over all investment decisions you make. Having to justify your decision to someone else will make it less likely you will trade. Put in a speed bump by thinking over your decision for a week before making a change in your portfolio. Remind yourself that there is someone else on the other end of your trade. They have made the opposite decision as you. Consider why might they be right, and you might be wrong.

The benefits of buy and hold investing

Buy and hold investing may be an anachronism but the benefits are undeniable.

Investing is a trade-off between risk and reward. In investment speak we define risk as volatility or how much an asset bounces around in price in the short-term. In riskier assets like shares we exchange that short-term volatility for higher expected returns over the long-term. The key word there is long-term. If you want to consistently achieve high returns from shares you need to hold them for long time periods so that the short-term drops in price can be counteracted.

There are other benefits as well. You will likely pay less tax. You will pay less in transaction costs which include both brokerage and the buy-sell spread. Long holding periods afford you the opportunity to reinvest dividends. That has a compounding effect on not just the number of shares you hold but also the income generated from your holding if you were to turn off dividend reinvestment in the future. Far outweighing these other benefits is the likelihood that longer holding periods result in less mistakes.

The rationalisations that lead to trading frequently are often simply justifications to make decisions that hurt our long-term performance. It may seem rational to sell because the market seems “risky”. It may seem rational to sell a position to buy the new ETF with the slick marketing campaign or to follow the advice of a mate who is pitching a can’t miss share. These rationalisations are often just cover for chasing performance.

Short-term top performers often face reversion to the mean. That is a fancy way of saying that after those periods of outperformance are periods of underperformance. That means that what you sell will likely do better than what you bought.

There is a cost to chasing performance which Morningstar has estimated at 1.7% a year and which I wrote about in a recent article. And there are other costs associated with over trading which account for differences between headline returns and the investing outcomes that are realised. My colleague Shani explored these issues in a recent article that she published.

Overtrading is giving up your biggest advantage as an investor

A universal truth of any competitive pursuit is that doing the same thing as everyone else is not a recipe for success. And far more than anything else a differentiated approach to investing simply means holding investments over longer time periods. There are structural impediments for many professional investors that make it hard to pursue that approach. There are none for individual investors. It is an advantage we are willingly and thoughtlessly giving away.

The reason that a long-holding period is such a powerful influence on investment returns is that it is far easier to predict what will occur over the next decade as opposed to the next six months. That does not mean that identifying the trends that will influence returns over the next decade is easy. But figuring out what will move markets over the next 6 months is impossible. Over the short-term the natural unpredictability of the world is just too big of an influence over a market fixated on the short-term.

For instance, since the start of 2022 the debate over interest rates have dominated market movements. I’ve found this debate exhausting because when and at what level rates peak is besides the point. The question that will influence market returns over the next decade is if the interest rate environment will return to the historic lows that we saw post-GFC or settle into a higher rate environment which more closely resembles history. I wrote in March my opinion that the global economy has structurally changed and we are in for a more normal interest rate environment. I very well could be wrong, but I do think that focusing on this long-term question is more fruitful than trying to base an investment decision on each new piece of inconclusive data.

Investors are naturally drawn to narratives. And I hear from investors constantly about the narratives that will influence the performance of investments. Many ETF providers have taken advantage of this need for a narrative with thematic ETFs. Robotics, AI and decarbonisation are just a few of the narratives that have captured investor attention.

Yet even a focus on thematics does not stop short-term thinking. I constantly hear from investors who will identify a thematic like decarbonisation and speak at length on how a move to a lower carbon world will influence different businesses and sectors. Fair enough.

The issue is that in the next breath they will ask me what specific shares will outperform over the next six months based on this theme. The disconnect between a multi-decade effort to lower carbon emissions and short-term security returns is stark. The world’s best personal trainer can’t help you lose 10 kilos in the next 24 hours.

My best advice is to leave the hypocrisy to other investors. Embrace the title of a buy and hold investor.