Good morning! Today Troy continues about the investing for beginners series. You can check the previous posts about What are stocks and how to value them, How does Currency Trading Work, How are Currencies Traded, Investing in Commodities, What Fundamentals Affect Commodity Prices, What are ETF’s, What are Options, How are Options’ Prices Structured, Investing for Beginners Part 2 – Different Investment Strategies
Buy and hold is the most common investment strategy out there. But you know what the problem is? Most people are doing it wrong! The part about “buy and hold” that Warren Buffett isn’t telling you is exactly what you should know if you do decide to buy and hold! In this post, I’m going to explain when “buy and hold” does not work. In the next post, I’ll show you how to make buy and hold work using an unconventional method.
Buy and hold is based upon a simple indestructible belief – over a long, long period of time (in a galaxy far, far away 😛 ), markets go up. Therefore, the savvy investor buys whatever investment he wants to buy, holds it for 40 years, and when he retires, he’ll be a bajillionaire! Warren Buffett said this, so he must be right! Don’t bet against America!
All jokes aside, Warren Buffett (and all those other politically-tied yahoos out there) are putting you out of the loop. You’re missing out on some key information here!
Fact Check #1: Markets Don’t Always go Up
The buy and holder’s basic belief rests on this – over the past 60 years, the average compounded return for the Dow Jones is 7% a year. Extrapolating into the future, the market will (over the long term) always deliver 7% a year.
As my grandpa liked to say “Na ah guys. Y’all getting it wrong.” These past 60 years in America (and much of the West) have been an era of unprecedented economic prosperity. You simply cannot extrapolate America’s Golden Age infinitely into the future. It’s like the 2nd century Romans saying that Roman engineering would always increase at 8% a year forever and ever. If that had happened, we would not have had the Dark Ages. This period of unprecedented economic growth (and stock market growth) is about to end – too many factors do not support such a historical anomally.
1. Rising raw material prices. When commodity prices rise, companies and their stock prices get hurt.
2. Technological bottleneck. Technology does not always advance at the same steady pace year after year. There can be decades without any significant technological breakthroughs, and then massive breakthroughs all of a sudden (eg the 1980s and 1990s). Over the past 10 years, nothing game-changing has really come out (and no, nanotechnology is not quite there yet). According to industry experts, “only improvements have been made”. iPads get thinner and thinner. The iPhone is really just an iPod with cellular capabilities.
If you look at other markets besides the stock market, things get even more depressing. If you “buy and hold gold” since 1980, you would have made a grand total of 40% over these 33 years. That’s less than what U.S. 30 year Treasury bonds are paying out!
So the “markets always go up” is actually a misnomer. It should be “the stock market always goes up, but cannot guarantee an average of 7% per year”.
Assuming You’ll Live 40 Years
Buy and hold assumes that you are actually able to “hold”. But what if (God forbid) you drop dead from a heart attack when you’re 53? After saving up all the money and reinvesting it into the stock market you die from a disease, wouldn’t your “buy and hold dreams” just have been wasted?
The conventional idea behind buy and hold is actually just another name for Get Rich Slow. Get Rich Slow is practically synonymous with Get Rich Old. Here’s why that’s not something you should bank on.
Assuming No Financial Disasters Happen in 40 Years
In order to buy and hold & get rich old, you need to make assumptions. You have to assume that your plan will work out to the letter, because the one thing that “buy and hold” cannot withstand is a surprise. And we all know that the weirdest and most improbably things can happen. An event like the 2008 market crash should have happened like once in 9 million years. Well it happened in our lifetime. Buy and hold assumes that you won’t face any financial difficulties.
What if you lost your job in a recession? The stock market has cratered by 50%, but to make ends meet at home, you’re forced to sell your investment portfolio at whatever price you can get (which is usually the lowest price).
For Warren Buffett, buy and hold is easy. Even if his wallet takes a 99% hit (mayday, mayday), he’ll still have $500 million left. If you lose your job, you’ll probably be forced to sell whatever you own just to put food on the table.