Buy and Hold: The Path to Wealth

by Jon Dulin on July 9, 2013 · 21 comments

It’s no secret that I am all for passive investing (also know as buy and hold). After looking at the data that 80% of active managers fail to beat the market in a given year, you are foolish to pay the higher expenses of actively managed mutual funds. (See my posts about what to look for in mutual funds if you need some guidance.) You are better off buying a low cost index fund and holding it through the good times and the bad.

Buy and Hold Works

I recently came across the below chart and it blew me away. It breaks out the annualized returns of over 20 year specific investment categories. It is interesting to see that after the huge run up in housing prices, the collapse has resulted in the annualized return to be just under 3%, which is roughly the historical average.

Buy and Hold

But the most interesting part is this: Look at the column for the S&P 500. Over 20 years, it has returned just under 8% per year. That means if you took your money and put it in an S&P 500 index fund and left it alone (buy and hold), your return would have been just shy of 8% per year for 20 years.

Now, scroll over to the right and notice the column marked as the average investor. The Average Joe returned a measly 2.8% per year over the past 20 years. How did they come up with this number? The study looked at mutual fund inflows and outflows of money. Another way to say this is the amount of money investors invested in the market and withdrew from the market. This doesn’t just mean money that you invested, then took out of the market to hide under you mattress. It also includes the times when you invest money into one fund, dislike your return, sell and buy another fund. That too is an inflow of money (purchasing the fund), an outflow of money (selling the fund), and then another inflow (buying the new fund).

Why such a drastic difference? The answer is because the lack of discipline and not understanding the importance of buy and hold. When the market drops, investors get scared and take their money out of the market. The market rebounds, but the average investor is still on the sidelines, scared. By the time he or she gets the courage to invest again, the majority of the run-up has occurred. Any gain is wiped out as they ride the market back down and sell at the bottom, scared that the market will continue to drop. This cycle repeats itself over and over again.

What does this difference in return look like in dollar terms? Let’s say you invested $10,000. After 20 years, had you invested in the S&P 500 and stayed invested, returning 8% annually, you would have over $46,000. If you bought and sold like the average investor does, you would have $17,000. That’s a $30,000 difference!

Buy and Hold

How do you avoid being another average investor? Buy and hold. Don’t sell when the market is tanking. It’s not easy. But you have to realize that the market is going to come back. It always does. Look at the drops as buying opportunities. My biggest returns were on investments that I bought after huge market drops. Try to think of it this way: when you are selling, someone else is buying. You can’t sell your stock without someone on the other side buying it from you. There are always buyers.

Tune out the media. They promote fear and exuberance.  If the market is dropping, don’t watch the news or read the paper. If you do, laugh when you see the picture of the person on Wall Street with anguish on his face. I swear they have that picture saved for these moments. They always show it.

Don’t look at your investments every single day. Seeing big swings or losses in your account will only magnify the issue, worrying you even more and eventually causing you to abandon your buy and hold strategy. Decide to look at your investments on a quarterly basis. If you need to look more often, then only do so after a really good day on Wall Street. Even if you have losses, you can focus on the fact that you made $X today.

Final Thoughts

Do what you have to do in order to stay in the market. It makes a difference when you constantly buy and sell all of the time. You may read everywhere about buying and selling and being an active investor. Remember that firms are encouraging you to trade because that is how they make money – through trading fees and commissions. You don’t have to trade to be a successful investor. In fact, as I’ve shown in this post, you will most likely be more successful by not trading and instead using a strategy of buy and hold.

Action Steps

You now know that you need to buy and hold when it comes to investing success, but how exactly are you supposed to do this when you get scared when the market drops? The answer is to invest with a firm like Betterment. They make investing easy. In 10 minutes you can create and account, set your goal and set up and automatic monthly investment. Betterment takes over from there, investing your money for you, rebalancing your account, diversifying your investments, everything. I highly encourage you to read more about Betterment in my review post. I’ve been a customer of theirs for over a year now and cannot say anything bad about them.

Another option for you when it comes to buy and hold is to learn more about the basics of investing. There is a lot of information about investing out there, but you really only need to focus on the basics to be successful.

I’ve written an eBook, 7 Investing Steps That Will Make You Wealthy, that does just this.  As you can tell from the title, it is all about investing and what you need to do in order to be successful at investing. Here’s a hint: you shouldn’t do anything mainstream media tells you and you should buy and hold. The eBook sells for $5 and comes in both PDF and Kindle formats (you get both for $5).

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{ 21 comments… read them below or add one }

Nick March 14, 2012 at 10:28 am

I'm a big passive investing guy, too. My favorite strategy is actually "buy and buy more" :)
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moneysma March 14, 2012 at 2:01 pm

Buy and buy more….I like it!!

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StockTipsInvestment November 1, 2012 at 5:55 pm

@Nick: If we do the same calculations between 2000 and 2010, the results would be very different. The results of the S & P-500 would be negative, the REITS would be very low, the highest gold etc. etc. Wait 10 years for the S & P-500 has a negative result is very frustrating. Between 1991 and 2000, Wall Street had a comportmiento hardly repeat that. Today, buy and hold, is too risky. You can lose a lot of your money.

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Money Infant March 15, 2012 at 12:48 am

Or become a contrarian. When everyone is screaming buy buy you should be getting into cash and when they all proclaim the end of free markets pile back in with all ya got. There's got to be a study out there that looks at contrarian investing?
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WorkSaveLive March 15, 2012 at 4:22 am

Fear and greed.

Two biggest mistakes investors make is pulling the money out when the market is going down, and the other is when they stop contributing until they "see things turn around."

Timing the market just doesn't work for the average Joe and by not continuing to contribute you eliminate the helpfulness of dollar cost averaging.
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moneysma March 15, 2012 at 2:07 pm

Well said. Sadly many investors missed out the recent run-up of the market because they are too scared to invest. You just have to invest and keep investing and tune out the short-term news stories.

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John S @ Frugal Rules July 9, 2013 at 8:39 am

Nice post Jon! I know many will derail buy and hold as ancient or something that does not work when, in actuality, it can work very well if you do it right. If you buy and forget then it may not work, but if you’re smart about it and not listen to the noise out there it can work quite well.
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Sean @ One Smart Dollar July 9, 2013 at 8:58 am

I agree with the buy and buy more. With the amount of volatility that is in the market it’s tough to just sit and forget while still making profits that are worth it.
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My Financial Independence Journey July 9, 2013 at 9:10 am

I’m strongly in the buy and hold camp. I believe in choosing my investments based on their valuations and underlying fundamentals and then holding them until they reach one of my exit criteria – which are all based on the emergence of substantive structural problems in the company rather than just gains or losses.
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moneysma July 9, 2013 at 7:08 pm

That’s a great way to look at investing. Many investors see a drop in share price and sell when there is no fundamental change in the business.

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krantcents July 9, 2013 at 12:46 pm

I think the key to buy and hold is thinking long term. You have to think about your long term goals and what will help you get there. The average investor stats do not surprise me! Part of the volatility of the stock market is due to the average investor skittishness.
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moneysma July 9, 2013 at 7:07 pm

Long-term focus is the key.

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Mark Ross July 9, 2013 at 7:54 pm

Buying more is really the way to go, especially to those investing for the long term. Buy more, indeed! :)
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Martin July 9, 2013 at 9:13 pm

I like the chart a lot! Hopefully I will not be among those average investors anymore.

There was a time in the past when I was laughing at and disrespecting buy & hold strategy as long as Mr. Market taught me a lesson. Today I am all over this strategy and wish i wasn’t that stupid in the past.

I started re-building my portfolio last year and not only I recovered it, but am seeing nice gains. Stocks like JNJ are showing 56% gain without dividends. With dividends I am around 150%. I have never been able to achieve anything like that trading!
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Brian @ Luke1428 July 10, 2013 at 9:04 am

Those people that are routinely pulling out money during market drops are looking at their portfolio too much and are not tuning out the media. I used to be in this camp and it cause me many sleepless nights.
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MarthaJ July 12, 2013 at 5:58 am

Buy at the perfect time, hold till the right time and let your investment/wealth simmer and surge while you, well, enjoy life. That’s how Jim Rogers, the legendary investor, trades his securities.
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moneysma July 12, 2013 at 1:41 pm

Great advice! The only note I would make is that the right time to buy is always now. Having time on your side is a powerful force.

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Pauline July 12, 2013 at 8:40 am

Congrats on the ebook! I do just what you recommend, invest monthly in a few indexes and dollar cost average, check it once a month at most, to avoid going crazy. Forex I trade and watch more carefully but it is more stressful.
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moneysma July 12, 2013 at 1:40 pm

I would consider my Forex to be my “play account”, meaning money that I am OK with losing. For everything else, it’s long term index investing.

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DivHut August 20, 2014 at 7:28 pm

Great article highlighting the importance of maintaining an investment discipline. This is why I like being a long term dividend investor. Through good times and bad your investment keeps paying you while you wait. In bad times your investment can dollar cost average down and buy more shares at cheaper prices. I held all my stocks during the 2008/9 meltdown and continued to add every month like I do now. This way you can accelerate compounding and reduce fees by not trading in and out of stocks too often. Thanks for sharing that graph too. Very telling.
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Jon Dulin August 22, 2014 at 8:16 am

Thanks!

Your outlook and actions for investing are spot on. Just keep investing, regardless what the market is doing.

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