HOW COULD A LOW-COST, PASSIVE, BUY-AND-HOLD STRATEGY DERAIL MY RETIREMENT?
Buy and hold has proven to be a sound strategy over the long-run. However, as shown in the hypothetical example below, it is possible to make no progress in the stock market for very long periods of time.
Assume we were invested in an S&P 500 Index fund for years and were able to accumulate $1,000,000 as of September 1, 2000. Not many retirement projections include an 11-year period with absolutely, positively no growth, but that is exactly what happened to a buy and hold S&P 500 Index fund investor between September 1, 2000 and December 20, 2011.
The graph below is a hypothetical comparison for illustrative purposes only. The dark orange line shows the growth of $1M via a passive, low-cost, buy-and-hold strategy using the Vanguard 500 Index Fund Investor Shares (VFINX) for the period 9/1/2000 - 12/20/2011. The yellow line shows the hypothetical growth of $1M with a compounded annual growth rate of 6.5%. In both cases, gains/dividends are reinvested.
For the passive S&P 500 Index fund strategy, we could draw a "no progress" horizontal line between the following dates:
When we compare the passive strategy to a "steady growth" strategy compounding at a 6.5% annual rate (yellow line in the graph above), several extremely important points come to light:
- Avoiding large drawdowns has significant mathematical advantages.
- The miracle of compounding can work for us (steady growth) or against us (large bear market drawdowns).
- The stock market, even for the most disciplined passive investor, can produce disappointing returns.
- Attempting to mitigate damage in bear markets is a logical investment goal.
- Focusing on steady returns rather than "impressive" or "market beating" returns can have a profound impact.
- If the stock market can make no progress for 11 years, a goal of "beating the market each year" seems misguided.
- A 1% gain over this 11-year period would have "beaten the market".
- Over the long-run (a bull and bear market), steady growth leverages the miracle of compounding.