“Buy-and-hold” — it was supposed to be the sensible strategy for investors with a long-term outlook. You buy stocks or funds that are likely to grow in value over long periods of time and you hang on to them even when they suffer short-term setbacks along the way.
But last year, that strategy seemed to implode as many buy-and-hold investors ended up with portfolios worth less than they were worth a decade earlier.
Now many investment strategists are declaring that buy-and-hold is dead, while others say that you shouldn’t abandon the strategy even after last year’s market plunge.
Bottom Line/Wealth interviewed some of the most innovative financial advisers in the country to find out how they’re adjusting their buy-and-hold strategies and how you can adjust your portfolio to do better in the years to come. What they recommend…
Edward Szado, CFA
University of Massachusetts
Take advantage of the “fear gauge.” The Chicago Board Options Exchange’s Volatility Index (VIX) measures investor fears about how volatile the Standard & Poor’s 500 stock index is likely to be over the next 30 days.
How it works: When professional traders expect the market to drop, they protect themselves by purchasing “put options” — contracts that give them the right to sell a stock at a specific price in the future. The more options they purchase, the higher the VIX goes.
Options can be too complex for most small investors to buy directly, but investing in the VIX has proved valuable as disaster insurance because the VIX tends to rise when there is financial turmoil. In the last five months of 2008, an investment in the VIX would have jumped 160% as the S&P 500 plunged 28%. Barclays now offers an easy way to invest in the VIX through the iPath 500 VIX Short-Term Futures Index (VXX). If you had a portfolio of 90% stocks and 10% in the VIX, you would have lost just 12% in the market collapse in the final months of last year. In the long run, holding an investment in the VIX could reduce your portfolio’s volatility.
You can learn more about the VIX at www.cboe.com/vix.
Edward Szado, CFA, is a research analyst at the Center for International Securities and Derivatives Markets at the University of Massachusetts in Amherst. The nonprofit center studies risk management and alternative investments. http://cisdm.som.umass.edu.
Jim Schlagheck
Retirement Revolution
Use a smarter index fund. I love the low costs and ease of using mutual funds that passively track indexes, but traditional index funds, such as those based on the S&P 500, have a serious flaw that became apparent over the past decade — they rank stocks on the basis of their “market capitalizations.” The more that a company’s total shares are worth, the more of its stock the index fund must own. In a rising market, the fund winds up owning more and more overpriced stocks, setting it up for an eventual crash.
Better: I use “fundamental” index funds, which determine how much of a stock to buy based on different valuation measures.
Example: Over the past 20 years, a dividend-weighted index would have achieved annual returns that, on average, were about two percentage points higher than those of traditional indexes.
My favorites: For the time being, I am 100% in cash because I expect that there could be a strong pullback in stocks. After such a correction, I expect to begin putting up to 40% of my portfolio in the following exchange-traded funds (ETFs) that mimic various fundamental indexes — 15% in WisdomTree Total Dividend Fund (DTD), which tracks US stocks that pay the highest dividends… 15% in the WisdomTree DEFA Equity Income Fund (DTH), which tracks foreign stocks that pay the highest dividends… 5% in WisdomTree Large-Cap Value Fund (EZY), which tracks stocks among the 1,000 largest US companies with the lowest price-to-earnings ratios (P/Es)… and 5% in WisdomTree Total Earnings Fund (EXT), which tracks US stocks with the greatest total earnings.
Jim Schlagheck is a private investment adviser living in Maine who counsels high-net-worth families and endowments. Previously, he led the North American Wealth Management and Financial Planning Division of UBS, one of the world’s largest wealth managers. He is also coproducer of Retirement Revolution, a PBS television series on how to better prepare for retirement, and he is author of Cash-Rich Retirement: Use the Investing Techniques of the Mega-Wealthy to Secure Your Retirement Future (St. Martins). www.cashrichretirement.com.
Leslie Beck, CFP, CFA
Beck Investment Management
Invest in announced mergers. So-called merger-and-acquisition funds can help stabilize your portfolio and improve returns with a strategy that doesn’t depend on what the rest of the market is doing.
How it works: When a deal for one company to buy another is announced, the fund purchases the stock of the company being acquired. Since deals can take months to close and can potentially unravel, the risk is typically reflected in a stock price that is slightly lower than that in the announced deal. If the deal goes through, the stock typically rises and the fund makes a profit.
My favorite: The Merger Fund (MERFX) holds about 40 stocks involved in pending deals. It has returned an average of 7.5% a year since 1989 and suffered only two years with negative returns over the past two decades. Last year, when the S&P 500 plunged 38.5%, the Merger Fund fell just 2.3%.
Performance: 4.2% (five-year annualized return through July 31 based on data from Morningstar, Inc.), 800-343-8959, www.mergerfund.com.
Leslie Beck, CFP, CFA, is president of Beck Investment Management in Palo Alto, California. Last year, she was named by independent research firm Goldline Research as one of the most dependable wealth managers in the US. www.beckinvmgt.com.
Louis Stanasolovich, CFP
Legend Financial Advisors, Inc.
Diversify drastically. Until last year, many investors believed that they were lowering their risk by diversifying into unique investments, such as commodities and real estate. Unfortunately, those asset classes collapsed right along with stocks and bonds during the recession.
Better: Devote 5% to 10% of your portfolio to “managed futures pools” to achieve some heavy-duty diversification. Managed futures pools allow you to bet on the price direction of gold, silver, grain, livestock, crude oil and natural gas, as well as on currencies. Managers of these pools have the opportunity to make money in any market environment.
Investing in managed futures pools on your own is very tricky, so instead buy shares in Rydex/SGI Managed Futures Strategy (RYMFX), a fund that tracks the Standard & Poor’s Diversified Trends Indicator index, which tracks 24 different asset classes. When almost everything plummeted in 2008, this fund gained 8.5%. Although the fund is just two years old, the index it tracks has 10-year annualized gains of 8.6%. 800-820-0888, www.rydex-sgi-fp.com.
