Buy and Hold: Your "Long Run" is the Only Important One

A Tale of Two Investors
What if You Live to be 100?
Buy-and-Hold on the Downside - Not a Good Plan
Returns for Current Buy-and-Hold Investor are Mixed
Buy at the "Right Price" to Make Money
The "Right Buy Price" Occurs in Clusters
20-Year Holding Period
30-Year Holding Period
40-Year Holding Period
50-Year Holding Period
Look into the Future Before You Buy
Conclusions and Recommendations

Advocates of the buy-and-hold investing philosophy tell investors to hold stocks for the long term. They argue that because the long-term trend of stock prices has always been up, investors will profit in the long term merely by using a buy-and-hold strategy. The argument implies that as you grow older, the value of your stock portfolio will increase. Is this always true?

Here we discuss the variability in the amount of money people make when they invest in the stock market for the long term. We use a variety of numerical and graphical techniques to examine buy-and-hold investing. All examples assume the investor made one $1,000 investment in the DJIA and let the investment grow or shrink over time.

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A Tale of Two Investors

This first example looks back to the DJIA in 1929. Assume you were 50 years old and invested $1,000 at the peak of the market in 1929 just before the market crashed. Your purpose was to buy the DJIA and hold on to your investment, watch it grow and reap the benefits in your retirement. You knew the market was high but the conventional wisdom said the market would keep rising so you placed your bet. Little did you know a crash was coming and your $1,000 would shrink to almost nothing and wouldn't recover until 1954, when you were 75. For 25 years you were losing money.

This was a true investing disaster. The chart shows the path of the investment from age 50 to age 100. Even if you had lived to the grand age of 100, your portfolio value would have been less than three times your original $1,000 investment. So much for buy-and-hold when you pay too much.

The second investor waited out the 1929 euphoria and subsequent crash and bought in 1932 after the market had found a bottom. The following chart shows how this investor's $1,000 investment grew.

When the investor was 75, the portfolio was worth over $10,000 and growing. Yes, there were significant fluctuations in value as the DJIA prices moved up and down but this investor experienced real wealth creation.

These two examples demonstrate that long-run results can vary immensely. The first investor bought at a very high price and was financially penalized for the rest of his life. The second investor bought at a very low price and his financial gains were never in doubt.

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What if You Live to be 100?

I know of a friend of a friend who is 100 years old. The value of her portfolio of blue-chip stocks is in the low seven figures. Suppose she had invested $1,000 at age 50 in 1953. The next chart shows the spectacular results of buy-and-hold investing.

At the market peak in 2000, the $1,000 had grown to over $40,000. Even with the price decline since the peak, she still has over $25,000. She has been lucky to have invested in a prolonged bull market, so her heirs will have some money to squabble over.

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Buy-and-Hold on the Downside - Not a Good Plan

The previous two examples showed the benefits of buy-and-hold investing. When you buy at a reasonable price and prices are in a long-term up trend, you make a lot of money.

But what happens to your returns if prices move down for a long time after you buy? The Japanese stock market provides data for such a case. Assume you wanted to diversify your stock holdings to include foreign stocks so in 1993 you invested in the Nikkei 225, the Japanese market equivalent of the DJIA. You knew the N225 had peaked in 1989 at 38,916 and you thought the subsequent decline in price to 17,024 gave you a great buying opportunity. So at age 50 you invested $1,000. The next chart shows the ensuing disaster.

As of the February 2003 close at 8513.54, the investment was worth $500. Buy-and-hold investing for this downside price pattern was a mistake.

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Returns for Current Buy-and-Hold Investors are Mixed

How has the current group of buy-and-hold investors fared in a market that has seen extreme ups and downs in the 10-years from 1993 to 2003? The following chart shows the path of dollar values for a $1,000 investment made in 1983, 1993 and 1998 in the DJIA. The last valuation is for the February 2003 close at 8018.11.

Assume each investor was 50 years old at the time of each investment. The 1983 investor, now 70, benefited from the long-term bull market. The portfolio value is worth $7,454, a sharp drop from the over $10,688 peak in 2000 but up more than seven-fold. The 1993 investor is 60 and also benefited from the 1993 - 2000 bull market. But the current portfolio value is only $2,422, two-and-one-half times the original investment after 10 years. The 55-year old investor, who started in 1998 at age 50, has barely made any money. After five years the portfolio value is $1,014, a meager $14 gain.

What do these previous examples of buy-and-hold investing tell us? The most important message is that buy-and-hold investing has mixed results. You can make a lot of money, a small amount or actually lose money. The unqualified assertion that buying and holding stocks for the long run ensures wealth creation is simply not correct. Sometimes buy-and-hold investing works and sometimes it doesn't. Several more examples help to demonstrate why.

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Buy at the "Right Price" to Make Money

Retail investors buy stocks every day with the hope of making a profit in the future. But to make money you must pay the "right" price. The next three charts show the current value (as of the February 2003 close of 8018.11) of one-time $1,000 investments made in the DJIA at different monthly closing prices. Each monthly purchase date on the horizontal axis of the chart has a corresponding purchase price.

The next chart shows the current value for a one-time purchase made at each of the closing monthly prices from October 1928 to January 2003.

The dollar values exhibit three important patterns. The spike on the left side shows that buying at relatively low prices gives the highest returns. The highest point on the spike is $187,339, which is the February 2003 value of the investment that was purchased at the DJIA value of 42, the July 1932 low price after the 1929 crash. Because this price is the lowest of all the purchase prices from 1928 to 2003, it gives the highest dollar value.

The second pattern on the chart is the general decrease in value as the purchase dates move from 1928 to 2003. This patterns results from the general increase in the DJIA price over time. So with time investors tended pay more to buy the DJIA.

The third pattern of interest is the variable nature of the returns. The up and down values, particularly on the left side of the chart, tell us that holding an investment longer does not necessarily ensure you make more money. Notice that many later purchase dates gave greater final dollar values than earlier purchase dates.

To understand this concept in detail, examine the next chart, which shows a close-up view of dollar values of investments made from 1973 to 2003.

The horizontal line on the chart labeled "$9,000 dollar value line" shows the different purchase dates that gave a $9,000 dollar value on February 2003. For example you could have purchased the DJIA on several dates from 1973 and 1982 and ended up with the same dollar value in 2003.

The next chart shows the outcomes for investors who started investing in 1993. Almost all the investments purchased from late 1998 to 2003 are losing money or just above break even. Buying at very high prices seldom leads to profits.

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The "Right Buy Price" Occurs in Clusters

The next four charts show the relationship between the purchase date, how long you hold the investment (holding period) and the final value of the investment purchase dates run from October 1928 to April 2002. $1,000 was invested for each purchase date and the subsequent value of the investment was tracked each month until the final date on May 2002. The final value of each investment was recorded. The holding periods are 20, 30, 40 and 50 years.

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20-Year Holding Period

The following chart shows the group (called a cluster) of purchase dates that produced a final value that was $10,000 or more for a 20-year holding period.

All of these investments were in a cluster of purchase dates from 1978 to 1982. These investments increased during the 1982 - 2000 great bull market so when they were valued between 1998 and 2002 their value had significantly increased. The highest dollar value, $13,899, was for the May 1980 purchase date. The lowest dollar value, $10,270, was for the January 1978 purchase date.

The purchase dates in the cluster are the only dates on which you could have purchased the DJIA, held it for 20 years and made 10 times or more on your money. Therefore, if you have a relatively brief holding period, you need to catch a rapid increase in prices to make highly significant return.

Recall the lows made in 1932 after the 1929 crash. Even if you had bought at those low prices and held for just 20 years, you would not have made 10 times your investment. Although prices increased after the 1932 low, they did not rise fast enough during the next 20 years to give 10-times your money.

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30-Year Holding Period

The next chart shows the three clusters of purchase dates that give a 10-fold gain for a 30-year holding period.

The first cluster includes purchase dates in 1932 and 1933 when the DJIA was making a bottom in prices after the 1929 crash. The purchase at very low prices ensured a 10-fold gain or more if you held the investment for 30 years. The second cluster includes only one purchase date, April 1942, a temporary low price. The third cluster includes purchase dates between 1968 and 1972. Buying at these dates and holding for 30 years meant you benefited from the 1982-2000 bull market.

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40-Year Holding Period

This chart shows the two clusters of purchase dates of investments held for 40 years that yielded returns of $10,000 or more.

The first cluster includes dates in 1932 and 1933. Notice this cluster has more dates than the similar cluster for the 30-year holding period. The second cluster has many purchase dates from 1946 to 1962. Holding these investments 40 years meant they were cashed out from 1986 to 2002, when prices were relatively high.

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50-Year Holding Period

If you hold the investment for 50 years, you don't have to be too fussy when you buy. The chart for the 50-year holding period shows one continuous cluster of purchase dates from 1932 to 1952 that yield a 10-times-or-more dollar value. The range of values varies widely from just over $10,000 to over $65,000.

The conclusions from the four cluster charts are:

Not all purchase dates (prices) are "good" buys. Therefore, the buy-at-any price strategy is not prudent, particularly for holding periods less than 50 years. Don't believe the "Wall Street Buy Propaganda Machine" that tells you to buy at anytime and then hold for the long run. Your long run might not be long enough.
Good buy prices occurred in clusters of low prices. Bargains don't occur too frequently.
There are long time periods between clusters of good buy prices. Be patient and wait for the price to come to you. Don't chase high prices.
Long-term returns increase when you buy at low prices.
Long-term returns increase when the holding period includes a steep rise in prices. Buy-and-hold investing works on the upside.
As holding time increases to 50 years, many prices are good buy prices if prices remain on a long-term upside. Long time periods tend to smooth out ups and downs in returns. Buy not all investors have 50 years to wait.

Will these conclusions be valid in the future? Maybe, maybe not. Remember that from 1928 to 2003 the DJIA has been in a very long-term trend of rising prices - even with the downturn in prices from 2000 to 2003. Our observations about buy-and-hold investing are based on historical price data that have been favorable for many long-term investors.

If prices were to enter a prolonged period of decline like the Japanese stock market after the 1989 peak, any buy-and-hold strategy would lead to negative results. Few investors would be immune from the financial disaster created by such a downturn. And investors in their 50s and 60s wouldn't live to enjoy profits from stocks.

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Look into the Future before You Buy

No one knows what stock prices will do in the future. The past tells us that returns vary because of the price we pay and in some cases because of how long we hold the stock. But the generalizations that holding stocks longer always gives higher returns and that timing doesn't matter in the long term need to be examined in the light of specific times and circumstances. Here's a checklist to use to protect yourself from over-generalization. Before you invest:

Determine the time over which you intend to invest, your investment lifetime (from now until you retire, for example).
Estimate future price patterns based on your investing experience and research (it's a good idea to compare the results of several forecasts).

Then, use the following guidelines:

If you expect prices will be on the upside during your entire investment lifetime, buy and hold stocks.
If you expect prices to be in a sideways pattern, time your stock purchases. Wait for low prices. Do not buy at high prices. Use CTM as an aid to determine when to buy and when to sell.
If you expect prices to be on the downside, do not buy. Wait until prices stabilize before you buy. DO NOT BUY ON THE DOWNSIDE. Use CTM to help you decide when to invest new money.

Remember that the price you pay for an investment ultimately determines how much you make in the short and long run. After you buy the investment, you cannot change the purchase price. So the lower the price you pay the higher the current value of the investment.

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Conclusions and Recommendations

In the Preface to the fourth edition of The Intelligent Investor by Benjamin Graham, Warren Buffett writes: "Whether you achieve outstanding results will depend on the effort and intellect you apply to your investments, as well as on the amplitudes of the stock-market folly that prevail during your investment career." . We could not agree more.

You cannot control the short-term or long-term price patterns of the market, even though your outcomes are in large part dependent upon them. If your investing experience coincides with a price pattern where you can buy at low prices, hold during a long-term up trend and then sell at much higher prices, you will do very well. On the other hand, if you invest when prices are very high and then hold, you may make money in the long term but you will not be rewarded with top returns. You will spend too much of the holding period just catching up to the high purchase prices. Investors who bought at near peak or peak prices in 1929 suffered the consequences for their entire investing career, be it 10 or 70 years. Time is not always on your side.

Will investors, who bought the Nasdaq in 1999 and 2000 at historically high prices have a similar fate? If they are wedded to a strict buy-and-hold strategy, they probably will. Remember that from 1928 to 2000 the DJIA demonstrated a long-term trend of rising prices. Consequently many long-term investors in the United States stock market have known only good times. However, if prices were to enter a protracted period of decline, like the Japanese stock market, any buy-and-hold strategy would lead to unsatisfactory results.

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Updated March 14, 2007.