Why don’t all investors use a buy-and-hold strategy?
Most people associate with one of two investment strategies; passive or active investments. Passive investors consistently buy securities, regardless of market price. This is better known as a ‘buy and hold’ strategy and founded in the belief you can’t time the market. Therefore, it’s best to invest consistently and profit from steady growth in the market.
Active investors are those who aim to time the market — better known as a “buy low, sell high” philosophy. They buy ‘undervalued’ stocks with the anticipation that they will be able to sell at a higher price. Active investors are regularly trying to ‘beat the market’ and perform deep analysis on when to pivot in or out of a particular stock.
For decades most investors were considered active investors. They picked individual stocks to trade and bought in lump sums. Frequently trading shares. But, the landscape has changed over the past decade.
ETFs have vastly grown in popularity. ETFs or “Exchange-Traded Funds” are a variety of pooled investment securities. One of the most common ETFs is a basket of the S&P 500. An S&P 500 ETF covers a basket of shares for some of the largest companies on the stock exchange. The rise in ETFs, like ones that cover the S&P 500, has made passive investment strategies more popular among investors.
And it makes sense because the S&P 500 outperformed 92% of active investors. So by putting money consistently into a simple ETF, you can have a better return than 92% of traditional investors. Seems like a no-brainer?
Wrong. Despite the alarming growth numbers, there are still MANY investors who believe active investments are superior. But, why?
Emotions.
It’s way more exciting to ride the highs and lows of the stock market than it is to invest consistently in an ETF.
No amount of statistical evidence can replace that feeling of tripling your money in a span of a few days because you bought and sold Gamestop at just the right time. Investors get a taste of this high and become addicted to the adrenaline rush. They are constantly chasing the next big trade. They will always talk about the times they ‘bought low and sold high.’ But, seldom speak of the times they bought in and panic sold because the stock tanked.
Investing in individual stocks, no matter what anyone tells you, is a gamble. There are no “sure things” or a crystal ball. No amount of research can tell you exactly what is going to happen in the market.
No one foresaw a pandemic striking in early March 2020 the markets to tank. No one could have foreseen the impact a Reddit page would have on a dated company’s trading price. No one can see when a natural disaster comes and wipes out a business's key location. Or any other crazy events that could happen. These events force even some of the most seasoned active investors to fold and panic sell out of emotion.
There are some who can navigate those tumultuous environments. I was scrolling through LinkedIn recently where I saw a small wealth management company boasting about their investment portfolio that outperformed the S&P 500. Their portfolio carried a 19.6% return compared to the broad market return of 18.4%. I commend them for being a part of the slim 8% of investors who can beat the S&P 500.
But, this company likely spent tens of thousands of hours researching exactly when to buy and exactly when to sell. They likely spent hundreds of thousands of dollars on payroll and other resources for people to do this. All for a measly additional 1.2% in return?
Between the cost of labor and resources, they surely spent that 1.2% additional return and then some. Instead, they could be using the time they spent researching these stocks to create other revenue streams and just invest in an S&P 500 index fund to get nearly the same return at a fraction of the cost. But, that’s not even the worst part.
Having a return that is 1% higher than the market is considered good, really good. As mentioned earlier, 92% of active investors are beat by the market. So this example is one on a short list, and it’s not even worth the time and effort.
And, that’s not to say Index Fund investing doesn’t take on the same risks. It does, but that risk is minimized because your money is spread across hundreds, sometimes even thousands of other stocks. So when one tanks, there are always others to pick up the slack. That type of diversity is what allows index funds to regularly see growth. When you invest in index funds you’re, like VTSAX, and hold for long periods of time your risk is minimal compared to that of active investors. Over the course of a 30-year stretch, the stock market as a whole has never seen a negative return.
There are undoubtedly the same highs and lows that active investors see, but your perspective is zoomed out allowing you to not panic and lose money at small dips, but to hold knowing the stocks will pick up again. This very principle is even recommended by Warren Buffet, arguably the most infamous, wealthy, active investor of all time is telling you it’s a proven method.
Picking stocks will be tempting to an investor. But it’s not easy to do and will often beat you down more than it brings you up. Don’t let the lure of getting rich quick fool you. No matter how boring it sounds, invest consistently, and hold for the long term, and you’ll be far better off.
