Optimality of Buy-and-Hold Strategies

Abstract

The buy-and-hold way of investing has been taken as gospel by many professional investors since the 1960s. In recent years, however, it has come under harsh attack from both academics and practitioners who claim its ineffectiveness in the face of increasingly volatile markets. This research takes a theoretical approach to evaluating its effectiveness by invoking a powerful optimality theorem to gauge its effectiveness or, more specifically, its optimality level. In terms of optimality level, we determine how well it fares against three other popular strategies – lock-in, random-timing, and stop-loss. To make the concept of optimality level practically operational, we set up a two-factor model to depict the market environment and use Monte Carlo simulation to determine the optimality levels of these strategies. In terms of average optimality level, our results show that, in general, buy-and-hold strategies outperform the other three strategies in stable market environment, but they are outperformed by lock-in and stop-loss strategies in volatile market environment.