If you have only recently started investing, you may have come across investing styles of legendary investors like Warren Buffett and Charlie Munger. You may have also heard them say things like "Our favorite stock holding period is forever" and "You don't have to pay taxes on unrealized profits". If you then consider the immense power of compounding, it does make a lot of sense.
Choosing one right company and holding it for decades can literally turn your fortunes upside down.
Say, you had invested $1000 in Walmart (NYSE: WMT) in 1980, in 2018, it would be worth $1.9 million.
Companies like Monster Beverages have grown at a CAGR of about 40% in the past 20 years. So an investment of $1000 in this company would be worth around $840K, a return of 840x.
A single company, Apple Inc, has created about 5% of the total shareholder wealth in the history of US publicly listed companies. Yes, one company is responsible for wealth creation of $2.7 trillion. If only you could have invested all your money in Apple 15 years ago... If only..
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The more you read about such success stories, the more you will be enticed to believe in the "Buy and hold" strategy. Around the world, you will encounter stories of such massive success, of tiny unknown companies ending up as the world's biggest and most respectable of companies. Thousands of investors must have made generational wealth by holding onto the right companies. But does this mean that you should also do the same? Can you just research and pick a few companies today and put all your money in them hoping that 20, 30 years down the line, they will turn out to be the next Apple, Amazon or Walmart, or something even bigger? Should you buy and hold forever?
If you had asked me a couple years ago, I would have said "Yes, definitely yes". I even had a list of companies that I thought would turn out to be impeccable wealth creators. But the more time I spend looking at past data, the more I realize that the odds of success in this strategy are extremely unfavorable. Let me explain.
Buy and hold works only if you buy the right thing:
The most important element for wealth generation is the power of compounding. But an important caveat to the power of compounding is that it works both ways, meaning it can be a powerful wealth creator but an equally good wealth destroyer.
Most success stories of decades long "Buy and Hold" often involve only a very few companies, a miniscule fraction of the total listed universe.
Out of thousands of companies that get listed, only a few manage to grow from unknown microcaps/smallcaps to giant behemoths like Apple, Google, Walmart, Amazon or Coca Cola. Hundreds of others remain tiny companies with subpar returns, and many others even go bankrupt. If you don't believe me, just look at the flagship index of any country twenty years ago and now. Many of those companies would no longer be in the index, and many would have even gone bankrupt. And if that can happen to big reputable companies that make it to, say S&P500 and NIFTY 50, you can only imagine the odds of a tiny company performing well in the coming twenty, thirty or forty years.
Finding exactly the right company to "Buy and Hold forever" is a task that is much more difficult than most people realize. It may seem stupid now why any sane person would not have invested in giants like Coca Cola or Amazon when they were tiny saplings. But you are using the most important advantage of hindsight to analyze these companies now. They did not have the history of growth and performance when they were small companies nobody knew about.
So yes, you may hit the jackpot if you put in your money in the right company and hold it long enough to gift it on your grandson's eighteenth birthday, but you may have to be either as proficient as Warren Buffett or as lucky as a Powerball winner to have the right stock certificates in that envelope.
Even if you find the right company, not all companies work all the time:
Even if you are able to find the right company, it may not actually give you good returns.
All companies go through phases of growth and stagnation (or worse, degrowth).
No company is an "all-weather" company. Zero. If you don't believe me, just look below:
Coco-Cola, a company that can be touted as a blue-chip in the real sense of the term, between the periods of 1997 and 2013 produced zero returns in its stock prices.
The same period of zero returns can be seen in any company, be it Walmart, Google, Apple or GE.
If you had tied up your money in Coca Cola, in say, 1996, you would have to wait for a decade and half for your money to actually move up.
So, even if you find the right companies, it is no guarantee that the period you chose to put your money in was the right time.
Imagine if someone had invested the same sum in a few other companies that worked well during this time, and multiplied his money, before putting the swollen sum in Coca Cola... They would be in for a personal show of the "power of compounding"
This might sound blasphemous to people who suggest naively that you can't time the market, but the proof is against them in this case. Timing is important.
So should you buy and hold forever then?
The facts suggest that hoping to create a generational wealth chest by holding a few stocks for many decades would be as difficult as finding a hay-colored needle in a haystack. You may need to get really lucky or really astute to find such companies, and at the right time.
So what should you do then?
Instead of "marrying" a few stocks and tying up all your money in them, for good or bad, it would be more prudent to be a little more active in your portfolio management.
I am not suggesting you to be as razor-sharp as a full-time trader, but atleast a rough idea of trends and fundamentals can help you gauge if a particular company is going to do well in the coming year or two.
Rotating your money to whichever stocks promise good returns over a foreseeable time seems like the best way to go, which is also what most institutions practice.
Again, if you don't have the time to do that, another prudent way is to put your money into index funds regularly and let the magic work for you. As long as the economy of your country is in an upswing, your index funds will generate positive returns for you. (If it's not, you may have more things to worry about than your stock portfolio).
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