Why buy-and-hold loses money

Money could be made by stepping aside when things are expensive and returning when things get cheaper.

By Jim Cramer Mar 10, 2010 8:20AM
Jim Cramer

By Jim Cramer, TheStreet


The most trenchant moment of the whole day Tuesday may have been some interview I heard with still one more fund manager who came on TV and was asked why the public isn't involved with this market.


I always listen with one ear, but the answer I heard was something like, "Why should you expect them to be? They have had two 50% declines in 10 years, and they won't be fooled again."


Yep, the public is unwilling to be "fooled again." The public has been destroyed by the stock market repeatedly, and you have made no money at all if you have stuck with the passive strategies advocated by both the professors and the professionals.

What is a shame is that the rally off the bottom in the last year is about recognizing the relationship between the value of stocks and the value of the profits underneath, and that both times we had declines the profits disappeared. The first time was somewhat predictable from the dot-com period, and the second from the overvaluation foisted on the market by leveraged hedge funds coupled with the need for credit, which dried up, that powered those hedge funds.


I rarely recommend books in these columns, but that combination I describe is at the heart of the stock market crash analysis of "Lords of Finance," a terrific read. All of the same forces were at work during the run-ups we had in 1999-2000 and in 2005-2008: easy money, borrowed money and a divergence between profits and the valuation of those profits.


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I'm not saying that therefore things are predictable -- and it is easy to look back and know what to do.


I am saying that the public could make tons of money if it sidesteps when things are out of whack on the expensive side and returns when things are on the cheap side.


It sounds so simple. But when I think about the anniversary of the bottom, and I think about the bottom in 2003, and I think about the crash of 1929, all I can conclude is that buy-and-hold eliminates any possibility of dodging what we now must believe are patterns of destruction inherent in equities. If you can't dodge them because your philosophy is to buy and hold because of some failed academic thesis, then you have no business owning equities, which is the tragedy of the ennui.


My conclusion is that the melding of the buy-and-hold, no-trade ideology with the booms and catastrophic declines that we must expect is a recipe for disaster.


Obviously, if you look at the volume, if you look at the continuing exodus from the market by the nontrading types, you know the failed and foolish ideology is alive and well. Therefore people, rationally, if they have been brainwashed into thinking that the ideology is truth, have no choice but to keep leaving despite the bountiful returns they have missed or will continue to miss as the market restores itself to equilibrium in relation to the profits the companies are now generating.


Jim Cramer is co-founder and chairman of TheStreet. He contributes daily market commentary for TheStreet's sites and serves as an adviser to the company's CEO.


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