Buy and Hold: Putting it to the Test
Oct 22nd, 2008 by Nut
This is a chart of how the S&P 500 has done over the past 40 years, which I consider “long term” enough to draw some conclusions. Why? Because I believe my money will be in the market for a little over 40 years, so that should be enough time to ride out the ups and downs and hopefully get that elusive 8% annual return we hear bandied about so often. My conclusions:
- Booms and busts are normal: This is one of the best things I think people can learn about charts: this stuff happens all the time, it’s been happening forever, and it will continue to happen. Don’t stress about it. People have said it millions of times before, “This changes everything.” No it doesn’t, it’s business as usual when stocks plummet like this. We are NOT special. Just look at the history and you’ll see. Here’s a recent article discussing just that.
- In retrospect, market timing in tempting: Just look at the peak in 2000 and the bottom in 2002—if you knew that was coming you could’ve gotten filthy rich. That’s one problem with charts—people see the dips and peaks and get greedy. They do the math on how much money they could’ve made had they invested and sold at just the right time (you would’ve almost doubled your money in five years). That’s the problem though—it’s impossible. You don’t know what’s going to happen. No one does.
- Buy and hold works: If you had invested $1,000 back in 1968 in the S&P 500 and had let it sit until today, you’d have a simple annualized return of 19%. That’s WAY better than 8%. Then again, if you started investing in 2000 you are in a world of pain right now, you’re simple annual return is almost -4%. And while that may convince you to try a different strategy, you’ve “only” been in the market for eight years, not 40. You need to give it time—water doesn’t boil in three minutes, it needs the full 15.
I realize that the 80s and 90s were huge bull runs where the market did very well, and all we can hope for is at least one of those runs during the next 40 years. But next time you look at a chart and start zeroing in on the dips and peaks, don’t forget that, at the time, no one knew that it was a peak. No one knew it was a dip. They were just as clueless then as we are today, and the only thing we can do is look at the long-term history of the stock market and hope for similar returns.
Now, if you’re investing in individual stocks and not indices, that’s a whole different story. One that I shall tackle at another time.
