The Dark Side of Buy-And-Hold

A lot of really smart people want you to be a buy-and-hold investor.

Warren Buffett thinks you should buy-and-hold. Jack Bogle does, too. And Tony Robbins just released another short book about how buy-and-hold index funders beat almost every money manager in the world.

What's more, I wrote a recent post on how buy-and-hold investing can allow you to retire tomorrow (if you have enough savings and a clear-cut monthly budget).

And if that's not all, I wrote another post on how simply buying and holding a few selected stocks can vastly outperform buying and holding an index fund.

So is the trading battle over? Is learning to trade a worthless endeavor? Should we all just buy some stocks or an index fund, hold our positions forever, and go about our lives?

Not so fast, my friend.

When you hear about buy-and-hold, you almost always hear about the long-term success stories:

I bought a stock in 1967 and it's gone up 76,198%!

Or you hear:

Buying-and-holding an index fund can turn $10,000 into $100,00 in 34 years!

While those stories and facts may be true, they don't paint the whole picture.

They don't tell us what happens when buy-and-hold goes bad.

For example, do you know what would have happened if we had bought the SPY (a mimic of the S&P 500) in March, 2000 and held it until March, 2003?

We would have seen our account gutted by 43.6%.

Furthermore, if we started at that time with a big initial account of half a million dollars, our $500,000 nest egg would have turned into a mere $218,000. And that's just our investing losses.

If we pulled $27,000 out each year for expenses (assuming we're surviving entirely by our investing returns), then our nest egg would have transformed into a paltry $129,000. Yikes!

The market came roaring back the next year, though, gaining a whopping 33%. Did that help?

Kind of. Yes, we made 33%, but that 33% was on only $129k, not our original $500k. So, even though it was a big year, we don't make as much as we would have if we got this return when we started back in 2000. But at least it seems like we're back on track.

Unfortunately, we're not back on track. Not by a long shot.

As you know, there was a winter storm coming later in the decade. In our hypothetical scenario, we would have been able to pay our expenses from 2004-2008 and actually see our nest egg grow. But then the bottom fell out during the financial crisis.

When the smoke finally cleared in March, 2009, our original nest egg of $500,000 would now be only $81,200 (after taking out our expenses each year).

Now the account is too low to make it back. We're doomed.

Yes, the market rose dramatically from 2009-2017, but our nest egg was too small to keep us afloat. Ten percent on $500k is a good amount. That more than meets our expenses. Ten percent on $81k is bad amount. We don't come close to paying our expenses. And so we're caught in a death spiral.

All told, if we started our buy-and-hold adventure in March, 2000, we would be totally out of money by 2017. The $500,000 would all be gone.

Here's the dirty little secret about buy-and-hold: It really, really matters when you start.

For example, if we use the exact same numbers as our death-spiral example but happened to begin in March, 2009 instead of March, 2000, by the end of 2017 we would have a nest egg of $1.1 million, even after paying out $27k for our expenses each year!

In one buy-and-hold example, we start with $500k and end up with nothing. In the other buy-and-hold example, we end up with $1.1 million. Exact same strategy, completely different result.

The only difference is when we randomly started the adventure.

Okay, what if we don't use SPY? What if we use a Vanguard Index Fund that everyone raves about?

Vanguard does do a little bit better. But if we started in 2000 like we did for the SPY, by the time 2017 rolls around, our $500,000 nest egg would have been reduced to $127,895. We're still solvent, but we don't have much chance of ever getting back to our original amount (the last time our account would have been above $200,000 was back in 2008).

Well, how about picking individual stocks? Would that work better for buy-and-hold? Not. Even. Close. Bud!

I did a post on an easy stock-picking system that did very well. Because I had the research from 2012 at my fingertips, I used 2012 as my starting point. Like I said, it worked fabulously (about 13% per year).

But what if we started at a different time? Would that have mattered? You better believe it.

Using my old research, if we started the same simple stock-picking system in 2006 and held for 5 years, a value portfolio I tracked would have lost 44% after the five years were over. Ouch.

And if we did the same for an IBD high-flying portfolio of ten stocks that started in 2008, we would have lost 4.4% after five years.

In fact, several of the individual stocks from those portfolios would have lost 60% or more in that five-year stretch (and haven't come back since). Ouch again.

This is a very important thing to consider if we're thinking of being a buy-and-holder.

The number one contributor to how our lives turn out is when we start. That's a lot of pressure. And we never know if we're starting at the "right" time.

That's the dark side.

There are solutions to that problem, though. One, you could save way more money and start our nest egg with a huge margin of safety.

For example, if we started our initial March, 2000 adventure with $1 million rather than $500k, we would have survived. We would have lost money along the way, but we would have our $1 million nest egg back by 2017. So we can overcome the dark side, but it will cost us the time and effort to increase our starting amount.

Or we can overcome this problem by being a trader and not sitting idly by watching the stocks we bought fall down, down, down.

It's that second option I'm most interested in. And we'll talking more about that very soon.

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