Tuesday, March 3, 2015

The Colossal Failure of Buy and Hold

15 years later the NASDAQ finally got back to 5000.  This proves once again that markets  have big drops but they always get back to where they started.  Buy and holders might be taking a victory lap over this but they would be missing the point.  Anyone who had money in the NASDAQ 15 years ago and didn't sell is back to where they were---their money is back but they will never actually recover because of the opportunity cost.

For example, lets say you have two investors, investor A and investor B.  Investor A put $1mm into a NASDAQ index fund at the top of the market.  Investor B put $1mm into some investment that averaged 5%/yr.

Today investor A has his money back, his account is worth approximately $1mm.  Investor B doubled his money, he has a little over $2mm.  If both investors are able to earn 5%/year over the next 15 years they will both double their account values.  Investor A will have $2mm 15 years from now and Investor B will have $4mm.   The longer out you go the bigger the gap.

The real problem with buy and hold is not that markets don't come back from losses, they do.  The problem is that investors can never get back the lost opportunity cost as the losses take so long to recover from.

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