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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.

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For the passive S&P 500 Index fund strategy, we could draw a "no progress" horizontal line between the following dates:

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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:

  1.   Avoiding large drawdowns has significant mathematical advantages.  
  2.   The miracle of compounding can work for us (steady growth) or against us (large bear market drawdowns). 
  3.   The stock market, even for the most disciplined passive investor, can produce disappointing returns. 
  4.   Attempting to mitigate damage in bear markets is a logical investment goal.
  5.   Focusing on steady returns rather than "impressive" or "market beating" returns can have a profound impact.
  6.   If the stock market can make no progress for 11 years, a goal of "beating the market each year" seems misguided.
  7.   A 1% gain over this 11-year period would have "beaten the market".
  8.   Over the long-run (a bull and bear market), steady growth leverages the miracle of compounding.
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