If you ever needed a lesson in the power of patience, let me
remind you of a date in recent history: March 9, 2009. On that day,
the Dow Jones industrial average closed at a gut-wrenching low of
6547. Stock prices had been cut in half in just 15 months. General
) had plunged from $38 to $7, Cisco Systems (
) from $29 to $14, and Bank of America (
) from $43 to $4.
Making money in the stock market is hard not because finding
great companies is difficult but because the best and
easiest-to-understand strategy for winning is so difficult to
adhere to. That strategy can be described in three words: buy and
hold. Five years from that 2009 bottom, the Dow was up roughly
10,000 points to a new record. No, the stock market doesn't always
bounce back so dramatically, but it always bounces back.
No matter what the chart followers say, the market does not rise
and fall in repeating patterns. If it's down sharply in a
three-year stretch, for example, it won't necessarily rise just as
sharply over the next three years. The market works on its own
timetable, but there are some eternal verities:
1. Stocks of large U.S. companies have reliably returned about
10% annualized over the past two centuries. They should do just as
well for the next two.
2. In the short term, the market can be risky--if we define risk
as volatility, or the severity of the ups and downs. In the long
term, the market is much, much less risky.
3. Individual companies can vaporize (Enron and Lehman Brothers,
to name a couple), but a diversified portfolio protects you from
the risk that an individual company will implode and provides a
4. Compounding is enormously powerful. Over long periods, small
price gains and dividend payouts mount up (but note that the
expenses charged by mutual funds, brokers and other advisers add
And that's it! That is all you need to know about succeeding in
the stock market. Buy a solid, low-cost, diversified mutual fund
(or assemble your own diversified portfolio), forget about it for
a long time, and you should do well. As an example, consider Dodge
& Cox Stock (
), with an expense ratio of 0.52%. Over the past 15 years, a
$10,000 investment in Dodge & Cox, a member of the Kiplinger
25, grew to about $40,000. At that rate, in another 15 years it
will become $160,000, and in another 15 years it will be $640,000.
And that spectacular growth comes from an annualized return of
9.5%, roughly the historical norm. Any 30-year-old who can put away
$30,000--not every year but just once--has an excellent chance of
becoming a millionaire by age 70. (For a look at one couple who
accumulated wealth by investing slowly and steadily, see our story
Strike It Rich!
Psychological hurdles. It is behavior that determines investment
success or failure--not knowledge or skill or luck. Benjamin
Graham, the Columbia University professor and financier who was
Warren Buffett's mentor, wrote: "The investor's chief problem--and
even his worst enemy--is likely to be himself." What he meant was
that people let their emotions get in the way of smart investment
moves. They tend to buy when stocks soar and sell when stocks
The selling part is especially dangerous because people want to
avoid losing. Richard Thaler and Cass Sunstein write in their book,
that academic research has found that "losing something makes you
twice as miserable as gaining the same thing makes you happy."
They point out that in 1992, participants in retirement plans
administered by Vanguard were allocating 58% of their assets to
stocks. But by 2000, as stocks had quadrupled in value, the
proportion rose to 74%. Then, as stocks fell sharply over the next
two years, the allocation fell to 54%. "Their market timing," they
write, "was backward." We saw the same phenomenon during the recent
cycle, with investors bailing out of stock funds as prices sank and
returning only recently, as indexes hit new highs.
The values that help you succeed in the market are the values
that Aristotle extolled: moderation, persistence and humility. The
question is how to adopt behaviors that fit those values when the
minute-by-minute noise of the market is so dramatic. Here's some
• One way to make yourself get out of bed in the morning without
hitting the snooze button is simply to move the alarm clock away
from your bed. The investment equivalent is moving stock-price
information as far away as you can. Twenty years ago, I told the
editor of the
's business section to quit running pages and pages of stock
prices. Stop encouraging readers to check how their shares were
doing each morning. The
did drop the tables, but mainly because readers can now get prices
by the second on their computers and smart phones. Don't fall into
that habit. Check your holdings once a month or once a quarter.
• Think of your holdings not in dollar terms but as investments
in great businesses. When GE drops in price, think of the event not
in terms of money that you have lost but in terms of someone else's
transitory valuation of your little piece of GE. Do you really want
to give up a stake in a wonderful company just because others
fleetingly believe it is worth less?
• For many investors, sitting still is not an option. They have
to do something. If you're in that category, I suggest you set up a
"fun and games" account, a separate portfolio that represents, say,
5% to 10% of your assets and in which you can trade to your heart's
content. Compare its results with that of your buy-and-hold
portfolio over five or ten years. Chances are high that your
emotions and the costs of trading have taken a toll.
• Make purchases in the same amount every month or quarter. This
technique, known as dollar-cost averaging, forces you to buy more
shares when prices drop. Instead of feeling bad about market
declines, you may actually feel good because you are picking up
more assets at better prices.
• Think buy, not sell. Hunt for bargains. The recovery, by the
way, is not over. For example, GE trades today at $26, still about
one-third below its 2007 high. Cisco sells for $22, also about
one-third off its high. Bank of America is at $17, still down 63%.
I recommend them all.
In urging a buy-and-hold strategy, I am not suggesting that you
mindlessly keep companies that have gone sour. The reason to sell,
however, is not that the price of a stock has declined but that the
business has deteriorated and is unlikely to recover--a key new
product has failed, a rival has started a price war, or the new CEO
is clueless. If you have chosen stocks well, these events will be
rare. And if you are wise, you will err on the side of keeping what
you have. If you had done that five years ago, your portfolio would
be up, oh, some 200%.
James K. Glassman is a visiting fellow at the American
Enterprise Institute. His most recent book is Safety Net. He owns
none of the stocks mentioned.