Don’t get me wrong. I am not saying that this investment strategy doesn’t work. In fact, it works very well in a super bull market.
However, investors who use the buy and hold strategy need to know that they will also have to face a huge amount of volatility.
Let’s take the broader stock market as an example to illustrate the point. Over the past 20 years, investors who are using this strategy would have faced a whopping market decline of -80% in 1998, -46% in 2001 and -47% in 2008. Not many investors have the tenacity to hold on to their stocks. Faced with such a huge decline, many often choose to sell low instead of the usual buy low and sell high since they cannot take the huge loss any longer.
With individual stocks, some of them never recover after a huge market decline and investors who hold on to their stocks would face a blow-up in their investments.
Is there an alternative to the buy and hold strategy that offers better risk-adjusted return? There is actually a simple trend following system that beats the buy and hold strategy. It uses the 10-month simple moving average (SMA), which is an average of a market’s closing prices over a year.
The trending system is quite straightforward: You buy when the monthly price is more than the 10-month SMA and you sell and move to cash when the monthly price is below it. You only need to update it once a month, such as on the first or last day of the month.
I did a backtest with this system on the ishare MSCI Malaysia ETF (exchange traded fund) from 1998 to 2018 (about 20 years). This ETF is an index fund composed of Malaysian stocks. I used this ETF rather than the KLCI stock market index because the data is easily available and also covers more than 80% of the Malaysian stock market.
The results are: The annual return with the trending strategy is 11.28% compared to 7.4% with the buy and hold strategy. An investment of RM10,000 at the beginning of 1998 would turn to about RM90,000 at the end of 2018 compared to about RM43,000 with the buy and hold strategy.
The annual return from the trending strategy also beat the annual return with EPF savings, which is about 5%-6% over the past 20 years.
What is even better is the maximum decline from top to bottom (drawdown) is -29% with the trending strategy compared to -67% with the buy and hold strategy. Hence, you would be able to duck the huge market declines during the Asian Financial Crisis in 1998, Dotcom crash in 2001 and subprime crisis in 2008. The trending strategy also has a better risk-adjusted return or Sharpe ratio.
The drawbacks are that you would lag behind the buy and hold investment strategy during the super bull market and also be subject to whipsaws at times.
The more enterprising investors can also use the trending strategy together with valuation analysis (price-to-earnings, price-to-book) or to their asset allocation (stock and bond in a portfolio) to further enhance their returns.
However, it is not a get-rich- quick formula. Investment success usually takes time and patience. Your results, no matter what kind of investment strategy you use, will also depend on the performance of Corporate Malaysia.
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