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.
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.
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.
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. If you find that Betterment isn’t for you, check out my online broker comparison chart for other options that better meet your needs.
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).