The Dividend Guy had this interesting chart on Dow Movements from May 26 1896 till Feb 2009. That’s right – it is 1896. The Dow was 40.94 on that date and on February 28th 2009, it was 7062.
In a period of 113 years, the Dow rose about 418 times. That should be a case for buy and hold right?
Wrong.
The Dow just returned 4.68% compounded annually in over a century. The power of compounding doesn’t become obvious till you play a bit with this concept. Use this CAGR calculator (Compounded Annual Growth Rate) calculator to do that.
How much do you think the Dow would be at today if it grew at 6% compounded annually?
It would have been at 28,984.
At 7%?
83,642
At 8?
239,300!
The power of compounding is really awesome and the best story to illustrate that power is the story of the Red Indians who sold Manhattan to America.
In 1626, Red Indians sold Manhattan to a group of immigrants in the equivalent of 24 dollars worth of beads and trinkets.
To understand what a great deal – the Red Indians struck, one needs to understand the power of compound interest.
At just 6% compounded annually – those 24 dollars would now stand at 118 trillion dollars!
A Case Against Buy and Hold Strategy?
Obviously, this is not good news for people who simply buy and hold. People who shun timing the market and instead focus on holding stocks for a long time.
I am part of this crowd with a slight difference. There are long periods of time when I keep accumulating cash and then there are long periods of time when I accumulate stocks. Most of the time, I don’t do both in the same period. Whenever I have done that – I have regretted it.
There is a lot of merit in buying and holding, but I feel that if I keep accumulating stocks, when the market is at all time highs, I will surely repent.
On the other hand, if I keep accumulating cash, when the market is at all time lows, I will surely repent. The thing to keep in mind is that the cash that I am putting in stocks is not earmarked for anything else for the next four or five years. If I need to sell these stocks for cash in the next four or five years – then I just keep such funds in a bank account.
I have been a heavy buyer since the markets went down and will continue to buy as long as the market remains depressed. Only time will tell, if I made the right or wrong choice, but, till then – Mr. Market, bring it on.
Miranda – I think the key to this is moving on to something other than what is overvalued.
For example – right now a lot of people are buying gold and gold denominated instruments banking on inflation and safety. Gold is already at all time highs and has typically risen over time.
When it goes beyond a certain point (maybe $1500 per ounce?) it will be time to get out of it and not buy more.
But that normally doesn’t happen.
Buying and holding (for eternity) doesn’t appear to be a well rounded strategy. There has to be some sort of Buy and Hold and Sell – if you have to protect yourself from the occassional recession or two.
I think over the long haul, a buy and hold strategy can work. But it’s all about moving it over to something other than stocks as your risk tolerance changes (i.e. as you move closer to retirement). I don’t think that there’s any one way to invest properly. And I think any number of plans can work, depending on how they are implemented.