Buy Right And Sit Tight How Right Is That?
One thumb rule, promoted by most investment consultants, is the buy right and sit tight strategy. In the long term, this will help you create good wealth. However, there are various drawbacks of this strategy such as there is no consistent winner among various asset classes like equity, debt and gold. This article takes a close look at the fallacies of this strategy and suggests an alternative option
You may have heard from investment gurus and financial planners that investors need to be disciplined and should invest from a long-term perspective. In short, they suggest a ‘buy and hold’ strategy. And though disciplined investing is something that we too are in favour of, we have our doubts about the buy and hold strategy. Having said that, a genuine question pops up which is that when the future is unknown and uncertain, how one can state for sure whether to buy, hold or sell a particular stock, index or mutual fund?
Of course, we can just come out with a probable situation but cannot predict it. This is the question that led us to analyse and understand whether or not at all the ‘buy right and sit tight’ is a prudent investment strategy, in particular for mutual funds considering that they are promoted more as long-term investments than stocks. It is equally important then to know if there exists a viable alternative.
Buy Right and Sit Tight
To begin with, let us understand what is the buy right and sit tight strategy is all about. As the phrase itself suggests, it is a strategy wherein you identify a stock or a mutual fund, invest in it and then forget it. According to this strategy, a quality stock or a mutual fund would always provide you with better returns in the long term. Consider the illustration alongside to understand this better. As an example, let us assume that you invest Rs 1 lakh in S & P BSE Sensex in November 2000 and forget about it till October 2020.
The above graph shows how your investment would have grown if you had adopted a buy and hold strategy in S & P BSE Sensex for 20 years. Your investment of Rs 1 lakh would have become Rs 10.46 lakhs in 20 years i.e. it would have grown by more than 10 times. And the compounded annual growth rate (CAGR) would be 11.79 per cent. All you did was to have bought it and then held it till the end of its tenure.
The above graph shows the three-year rolling returns for the same period as has been considered for our case study. Here we can clearly see that the three-year returns have fallen quite a bit lately and have also turned negative. Although the average three-year rolling return is 15.53 per cent, the variation in returns is huge. There was a period when the returns were greater than 50 per cent, while during other instances they were negative 10 per cent. Nonetheless, deeper analysis shows that it is more due to a polarised performance of the Sensex constituents where a few stocks did exceptionally well while a majority of them performed poorly. For these reasons, the buy and hold strategy may not always work.
Debunking the Strategy
There are four things that make the buy right and sit tight strategy futile.
We all know the importance of diversification. You may have heard the maxim of never putting your eggs in one basket. Hence, asset allocation has its own advantages. So, let us move on to the basics and understand why we need to diversify and have a proper asset allocation in place. One particular asset class is never a consistent winner. Though equity as an asset class performs better in the long run, that does not deem it a winner all the time.
The above table shows the annual returns of each asset class for the period 2010 to 2019. The returns of equity are the average returns of equity mutual funds; returns of debt are the average returns of debt mutual funds; and for gold, the returns are average returns of gold exchange traded funds (ETF). The table depicts how no asset class is a clear winner on a consistent basis. Hence, if you had invested in a fund and left it to grow, chances are that for some years it might have performed exceptionally well while in other years your investment would have lost most of the gains made during the good years. Hence, the buy and hold strategy doesn’t always lead to gains.
Similar to the asset classes, even in the case of sub-asset class, there is no clear winner. The sub-asset class is a further division of categories in a particular asset class. For instance, in equity asset class there are sub-asset classes like large-cap, mid-cap, small-cap, multi-cap, etc.
consistent outperformer on a continuous basis. This shows that even at the broader level if the asset class chosen is right, the wrong choice in sub-asset class selection can ruin your portfolio. Therefore, in such cases too, the buy right and sit tight strategy doesn’t work.
Financial goals help you channelize your investments in a way that you do not take any unnecessary risk for short-term goals and avoid being over-conservative on long-term goals. As a thumb rule, it is prudent to shift your investment to conservative instruments when you are nearing your financial goals. This often helps you to book profits and move to safer instruments in order to avoid unnecessary volatility and short-term risk. This can best be exemplified in the current scenario when the drastic fall in the equity market in the first quarter of 2020 would have wiped out most of the gains of earlier years with high chances of you not building up adequate amount to fulfil your financial goals maturing at the time. Hence, even in this case, the buy and hold strategy does not stand on firm ground.
When it comes to mutual funds, there are more than thousands of them available in the market. However, there is no fund that is consistent performer. Winners do rotate in this case as well. Hence, if you are investing in a few funds and then putting them on the back burner, this can definitely dent your portfolio quite a lot. Let us take the example of HDFC Top 100 Fund, erstwhile HDFC Top 200.
This fund was one of the best performing mutual funds before 2010. However, post that its performance started deteriorating with respect to the S&P BSE Sensex. The two graphs show the performance of the fund starting from two different times, one from the year 2008 and other from the year 2010. One point is clear: no fund can always be a winner. Therefore, you need make a timely exit from the fund before it leads you from the riches back to the rags. Therefore, in this sense as well, the buy and hold strategy won’t work.
Dynamic Investment Strategy
Now that we have discussed the buy right and sit tight strategy and studied its futility, the next obvious question is which should be considered a ‘prudent’ strategy? Let us understand then the dynamic investment strategy and how it proves to be a better strategy than the buy and hold strategy. Dynamic investment strategy is nothing but changing your asset allocation dynamically from equity to debt and from debt to equity depending upon the market valuation metrics such as price to equity (PE) along with various other economic parameters. This means that when the markets are overvalued, the portfolio would be more tilted towards debt.
On the flip side, if the markets are undervalued, the portfolio would consist more of equity. To help you understand this, we will show you our proprietary ‘equity sentiment index’ which helps us to take tactical calls on asset allocation. As is clear from the above graph, our proprietary index has given the right calls. Thus, taking calls based on such a sophisticated tool would help you to exit from assets with stretched valuations and invest in under-stretched assets. Now let us move on to compare the dynamic investment strategy with the buy right and sit tight strategy. For illustration purpose, we have assumed that you have invested Rs 1 lakh with a buy right sit tight strategy that would in turn invest in Nifty 50 and Rs 1 lakh in debt. Whereas, another Rs 1 lakh is invested using a dynamic investment strategy.
While investing with a dynamic investment strategy, the equity part gets invested in Nifty 50 and the debt part gets invested in S & P BSE 10-Year Sovereign Bond Index. Further, we have taken into consideration the monthly returns of Nifty 50 and S & P BSE 10-Year Sovereign Bond Index. Also, we have done monthly re-balancing and while doing so we have ignored exit load and taxes, if any. The period of study is from January 2000 to October 2020.
The below table shows you the risk and return metrics of different strategies. You may think that the buy right and sit tight – debt strategy is better. However, we need to understand that low risk would always mean low returns. However, in case of the dynamic investment strategy, it yielded high returns with reasonable amount of risk. In fact, if we look at the risk metrics of both the strategies, there is very less difference.
We come across a lot of thumb rules while investing. Some are good and some can be ignored. One such thumb rule, promoted by most investment consultants, is the buy right and sit tight strategy. In the long term, this will help you create good wealth. However, there are various drawbacks of this strategy such as there is no consistent winner among various asset classes like equity, debt and gold. Also, in terms of sub-asset class and mutual funds, there is no clear consistent best performer. More so, the financial goals are different and need different strategies for different goals.
Hence, in most cases the buy and hold strategy is nothing but a hollow promise and one should avoid it. In fact, to be a successful investor you need to take charge of your investments. The only scenario is which the buy right and sit tight strategy works is holding the bonds till maturity (also known as accrual strategy) in a rising interest rate scenario. In fact, this strategy would help you to technically avoid interest rate risk arising out of bond investments. For the rest, it is prudent to adopt a dynamic investment strategy.
Our study also reveals that dynamic investment strategy is a prudent investment option that helps you generate higher returns in the long term by undertaking reasonable risk. In the absence of a sophisticated tool such as ‘equity sentiment index’, you can simply use the PE ratio of Nifty 50 and its 50-day moving average to take dynamic investment decisions. If the Nifty PE is more than its 50-day moving average, increase the share of investments in debt while reducing in equity. If the Nifty PE is less than its 50-day moving average, have more in equity and less in debt.
❝Market timing, by the way, is a tag some buy-andhold investors use to put down anything that involves using your brain. These are the same people who like to watch the locomotive coming and get run down in the name of discipline.❞
Jeremy Grantham, a well-known British investor