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(Iuliya Sunagatova/Iuliya Sunagatova/iStockphoto)
(Iuliya Sunagatova/Iuliya Sunagatova/iStockphoto)

Portfolio Strategy

No shame in sticking to your investments Add to ...

Buy and hold: It never gets old.

The most utilitarian investing strategy of them all took a beating during the worst of the bear market, but it still rules for most people. Buying and holding does not make you a sheep, a sucker or a patsy of the investment industry.

The Portfolio Strategy column's argument in favour of buy and hold rests on four points:

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*Even losses from catastrophic market collapses like we saw in 2008-09 can be overcome in a reasonable period of time.

*Investors can get an overly negative view of their holdings by ignoring the dividends and interest payments they're receiving even as the price of their stocks, mutual funds and exchange-traded funds fall.

*Investors can reinforce this negative view by focusing on the worst performers in their portfolios.

*Pulling out of the market at a dire moment can lock in losses while also effectively eliminating your ability to make back what you lost.

Let's say you were unlucky enough to have invested $10,000 in Canada's largest mutual fund, Investors Dividend, in January 2008. The stock markets peaked a few months later, and then began to fall. So bad was the decline that by the end of 2008, this $13.3-billion behemoth had a 12-month loss of 22.4 per cent.

Investors Dividend rallied somewhat in 2009 and it's up a bit this year, too. Combine all the ups and downs and your $10,000 invested in January 2008 would be worth $10,546 as of November. (That's according to a tool available in Globeinvestor.com fund profiles.)

Now take a look at another mutual fund giant, the $12.1-billion RBC Canadian Dividend fund. A $10,000 investment in January 2008 would have been worth an estimated $10,697 as of last month. Meanwhile, a $10,000 investment in the $6-billion CI Harbour fund would have been worth $10,466 at mid-week. Even if you bought these popular investments near the market peak, you could well be back to making money again.

Dividends are key

Thanks to reader Jean Richer of Ottawa for highlighting one of the main reasons why portfolios have snapped back from the depths of 2008-09 - dividends. In his case, he benefited from dividends paid by the exchange-traded funds he owns.

"As we review what has happened since the fateful 2008-2009 swoon, it seems to me that those who grimly held on, unimaginatively, stoically, masochistically, to their broad [market]ETFs have fared not so badly," Mr. Richer wrote in an e-mail.

Mr. Richer used an ETF called the iShares S&P/TSX 60 Index Fund (XIU) to make his case. The share price was $18.82 early in 2008, and $18.18 on the date several weeks ago when he wrote his e-mail. But, as he noted, this comparison leaves out the total $1.24 per share in quarterly cash dividends that XIU paid out over the same period. With dividends in the picture, the 3.4-per-cent cumulative decline in XIU's share price turns into a total return of 3.2 per cent.

That's a low return over a period of almost three years, but there are some mitigating factors. For one thing, XIU has shot up close to $19 lately. Also, buy and hold looks better with a diversified portfolio. Let's use a very simple example where you invested $6,000 in XIU and $4,000 in the iShares DEX Universe Bond Index Fund (XBB) at the beginning of January 2008.

The bad news: A loss of $367.44, or 3.7 per cent, based strictly on changes in the share price of XBB and XIU (brokerage commissions not included here). The good news: A total return of $503.22 as of Nov. 30, or 5 per cent. (Portfolio returns calculated by the portfolio tracker on the Globeinvestor Gold website. The total return is based on dividends from XIU and bond interest paid by XBB.)

From today's vantage point, it's easy to look back and say that a buy-and-hold approach was right. But what about the pain of actually living through a market crash?

In calendar 2008, the XIU-XBB portfolio fell 16.7 per cent. Your attitude toward that kind of loss in a horrible year depends on your perspective. Your XIU shares plunged 31.5 per cent, which is stunning. But your XBB shares rose 5.7 per cent, enough to offset much of the damage caused by XIU.

Look at the big picture

The lesson here is that certain holdings in your portfolio may test your commitment to buying and holding. Ignore them and focus on the whole portfolio.

If buy and hold isn't for you, then what's your alternative? Will you be able to time your moves in and out of the market in such a way that you get better results than people who stay put? Probably not, and here's why. When you bail out on a plunging stock market, you face three stiff challenges:

*To get out well before the market hits bottom: There's no point in selling if you don't protect yourself from further losses.

*To find a safe but productive place for your money.

*To get back into the market at a point where there's still lots of upside.

Let's say you managed the first challenge, getting out of the market before the bottom. More than likely, you tripped over the next pair of challenges.

The financial analysis firm Investor Economics reported recently that an all-time high of $1.6-trillion is sitting in conservative investments, with $900-billion in liquid investments or savings accounts. This tells us that many people missed out completely on the stock market rally that began in March 2009, and they're earning nothing or close to it in their safe investments.

Here's an example of how the flight to safety could put you at a disadvantage to buying and holding. Say you start with the same $10,000 investment in XIU and XBB at the beginning of 2008. At the end of September, sick about how much XIU was down, you sold it, put the proceeds in a big bank money market fund and left it there.

Assuming you kept your holdings in XBB, your portfolio would have been down 1.1 per cent as of Nov. 30, with dividends and interest payments included. In this case, missing the market bottom was of no benefit because you missed the big turnaround.

Holding on to your investments can seem sheep-like in a plunging stock market, and yet it's the best approach for most investors in the longer term. If buy and hold doesn't make sense to you on its own merits, just consider the alternatives.



Here is an example of how a buy-and-hold approach through the market crash of 2008-09 might have compared to selling in the middle of all the carnage. We'll use a pair of very simple portfolios made up of exchange-traded funds purchased at the beginning of January, 2008.



The Buy and Hold View

Portfolio

Initial Investment

Current Value

Change in Price

Income Received

Total Cumulative Return

iShares S&P/TSX 60 Index Fund (XIU)

$6,000

$5,488.32

-8.50%

$364.97

-2.40%

iShares DEX Universe Bond Fund (XBB)

$4,000

$4,144.24

3.60%

$518.44

16.60%

Total Portfolio

$10,000

$9,632.56

-3.70%

$870.66

5.00%

The Buy and Flee View (you got out of the stock market at the end of September, 2008, and bought a money market fund with the proceeds)

Portfolio

Initial Investment

Current Value

Change in Price

Income Received

Total Cumulative Return

iShares S&P/TSX 60 Index Fund (XIU)

$6,000

-$5,047.84

-15.90%*

$103.77*

-14.10%*

iShares DEX Universe Bond Fund (XBB)

$4,000

$4,144.24

3.60%

$518.44

16.60%

Big bank money market fund

$5,047.84

$5,120.33

1.40%

$0.00

1.40%

Total Portfolio

$10,000

$9,264.57

-7.40%

$622.21

-1.13%

Notes: "Income Received" is dividends for XIU, bond interest for XBB. "Current Value" is to Nov. 30 (the stock market gains seen in early December would make the buy-and-hold case stronger). "Total Cumulative Return" means share price change plus income dating back to the portfolio set-up date.

*These numbers apply to XIU at the moment it's sold

Follow on Twitter: @rcarrick

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