Is Buy and Hold the Right Strategy

A lot of people have got rich by investing in shares and simply holding on to them for a long period of time. Buy and hold is a passive strategy, a very easy and comfortable way of investing in shares. But the last couple of years, buy and hold investors have not made any progress. Is buy and hold still the right strategy for investing in shares?

Buy and hold worked very well on the stock markets in the 80s and 90s. As long as shares go up, on average, at least 10% per year, the compound interest will create small fortunes even out of modest amounts. Buy and hold is a very simple strategy and it requires very little ongoing work.

You may already know that compound interest over time works wonders. But this requires that the annual growth is reasonably high. It must be at least a few percent higher than the inflation, otherwise you are not building any real wealth.

What becomes of $2400 invested each year, at different growth rates

Year Amount 4% 6% 8% 10% 12% 14%
1 2,400 2,496 2,544 2,592 2,640 2,688 2,736
2 4,800 5,092 5,241 5,391 5,544 5,699 5,855
3 7,200 7,792 8,099 8,415 8,738 9,070 9,411
4 9,600 10,599 11,129 11,680 12,252 12,847 13,464
5 12,000 13,519 14,341 15,206 16,117 17,076 18,085
6 14,400 16,556 17,745 19,015 20,369 21,814 23,353
7 16,800 19,714 21,354 23,128 25,046 27,119 29,359
8 19,200 22,999 25,179 27,570 30,191 33,062 36,205
9 21,600 26,415 29,234 32,368 35,850 39,717 44,010
10 24,000 29,967 33,532 37,549 42,075 47,171 52,907
11 26,400 33,662 38,088 43,145 48,922 55,520 63,050
12 28,800 37,504 42,917 49,189 56,455 64,870 74,613
13 31,200 41,501 48,036 55,716 64,740 75,342 87,795
14 33,600 45,657 53,462 62,765 73,854 87,071 102,822
15 36,000 49,979 59,214 70,378 83,879 100,208 119,953
16 38,400 54,474 65,311 78,601 94,907 114,921 139,482
17 40,800 59,149 71,774 87,481 107,038 131,399 161,746
18 43,200 64,011 78,624 97,071 120,382 149,855 187,126
19 45,600 69,067 85,885 107,429 135,060 170,526 216,060
20 48,000 74,326 93,583 118,615 151,206 193,677 249,044
21 50,400 79,795 101,741 130,696 168,967 219,606 286,646
22 52,800 85,483 110,390 143,744 188,503 248,647 329,513
23 55,200 91,398 119,557 157,835 209,994 281,173 378,381
24 57,600 97,550 129,275 173,054 233,633 317,601 434,090
25 60,000 103,948 139,575 189,491 259,636 358,401 497,599
26 62,400 110,602 150,494 207,242 288,240 404,098 569,998
27 64,800 117,522 162,067 226,413 319,704 455,277 652,534
28 67,200 124,719 174,336 247,118 354,314 512,599 746,625
29 69,600 132,204 187,340 269,480 392,386 576,798 853,888
30 72,000 139,988 201,124 293,630 434,264 648,702 976,169

As can be seen in the table above, over time even small amounts become huge over time. But you need a reasonable annual growth rate, otherwise it will take far too long. At 4%, your money does not grow much. It gets better at 6% but you still have to wait at least 30 years before the compound interest really starts to work. You really want at least 8% annual growth in order to start enjoying the magic of compound interest. But look at the difference between 8% and 10%, after about 25 years the difference of only 2% in annual growth starts to explode. At 12% growth, your money doubles every six years. As can be seen in the table, at this growth rate, even small amounts become huge within a reasonable timeframe. Of course, at 14% the magic of compound interest kicks in early. But it is far from easy to achieve 14% over 20 years or more.

Cheap index funds are the best solution for most people who want to invest using the buy and hold strategy. It has turned out that very few active managed mutual funds manage to beat cheap index funds over longer periods of time. When looking at performance over ten years or longer, cheap index funds are only beaten by about ten percent of the actively managed funds. And extremely few mutual funds manage to beat index funds with any significant amount. Also note that in reality index funds are even performing better than the statistics show. The actively managed funds only include the funds that have survived for ten years or more. Funds that have been closed or merged into other funds are not included. In almost every case the funds that have disappeared have been underperformers. Thus, the chance of selecting an actively managed fund which can significantly beat a cheap index fund is extremely small. Just selecting a fund that can match an index fund over longer periods of time is very difficult.

But some people insist on that individual investors can beat index over time. Most mutual funds are simply too large to be able to just select the few shares which they really believe in. A small investor on the other hand can invest in just a few companies. But if you want to beat index, you have to be prepared to take bigger risks and also to sell underperformers, which is not what a buy and hold investor would do.

In the 1980s and 1990s it was relatively easy to find shares that performed better than index for a very long time. Those who bought shares that increased ten or twenty fold got wealthy by just hanging on to their shares. You can still find such shares but it has become much more difficult. Needless to say, holding on to underperforming shares is not the fast way to riches.

So is buy and hold still a viable strategy on the stock markets? It certainly is the easiest strategy for most people. Unfortunately, it may not work as well as earlier, due to the fact that the last couple of years many stock markets have performed poorly. But unless you are prepared to learn about the stock markets and analyze shares, investing in cheap index funds and holding on to the investments is the best option. Despite the relatively poor performance of many stock markets, it is still advisable to have a large portion of your wealth in shares. But it can be worth looking at shares outside Europe. The US stock market may recover but it looks like many European stock markets will underperform for quite some time.

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