Maybe You Can Buy And Hold

Something occurred to me about buying and truly holding that I had not thought of before. In a way this will seem obvious, and I concede that, but still. This is most relevant for people in the accumulation phase.

A couple of years ago I put up a post about my Health Savings Account and the contributions I make to it. To paraphrase that post, an HSA now has $6150 annual contribution limit. If this is your first year and you can put in the max you have $6150 in the account before any investment results.

Assuming the law and your circumstances do not change net year you will put in another $6150 so after year two you have $12,300 before any investment results. As for investment results, whether you made or lost 10% (or any other reasonable number), they are far less important than the second contribution which doubled the size of the account.

Additionally, and this is the different twist, that second year's contribution becomes an allocation device. To pick an extreme example let's say in year one the entire $6150 goes into the Market Vectors Egypt ETF (EGPT). That is clearly an aggressive allocation. If the contribution for year two just goes into cash or some sort of short term debt instrument then the volatility has just been cut in half.

If the contributions that come in every year also go into cash then pretty soon the account's volatility is much different than it was in year one. An account that is 75% cash and 25% in a country fund (remember an S&P 500 index fund is a country fund) looks pretty conservative and gets to a related point I have brought up a couple of times before.

At a past job a coworker was very intrigued (obviously I find it intriguing too) by the concept of a portfolio that went short Nikkei futures with 2% of the account leaving the other 98% in cash. He said the return was the same as the US stock market. The specifics of the trade and whether he was right or not are irrelevant what is intriguing is the idea of a portfolio matching the stock market with only 2% exposed to risk. This is not a feat that many people can pull off but the concept and what it says about risk adjusted returns is fascinating.

So if Egypt were to average 30% per year (nothing is that uniformly distributed, this is a conceptual post) then the 25% exposure during year five offers equity market returns for the entire account with 75% sitting in cash. In that context the need to sell becomes a lot less.

This can be thought of as (sort of) safer leverage. As opposed to a paper put out by Ian Ayres and Barry Nalebuff that avers levering your retirement account if you are young. David Merkel takes a chainsaw to this idea.

While this is more of a theoretical idea of course any implementation remotely close to this would require a large savings rate which means living below your means. As you get older and probably should take the foot off the accelerator some new cash into whatever vehicle becomes an asset allocation device. In addition to over-saving (living below your means) this sort of thing requires some real study of the concept of risk adjusted returns.