(Click to enlarge.)
Using the SPDR S&P 500 ETF to represent the S&P 500 stock market since the ETF inception in 1993, the chart above shows the effect of:
- Blue: Holding the entire time. “Buy & Hold”
- Red: Missing the 10 best days only.
- Yellow: Missing the 10 worst days only.
- Green: Missing both the 10 worst days and the 10 best days.
I found this via TheBigPicture, but disagree with the idea that you should try to find out how to miss the 10 worst days avoid the worst days in general. [Edit: See comments for more.] I see no evidence at all that anyone has the ability to predict/avoid the best or worst days ahead of time.
I also don’t agree with the idea that this supports Buy & Hold because you don’t want to miss the 10 best days. Again, if you miss the 10 best, you’re likely to be missing the 10 worst. It works both ways.
The fact that you end up with more money by missing the 10 worst days and less money by missing the 10 best days simply gets a “duh” reaction from me. The bigger divergence recently just reaffirms that prices have been a lot more volatile in the last couple of years.
Instead, the focus should be on that fact that if you take out both the 10 worst days and the 10 best days, you’ll basically do just as fine as buy & hold. Stock market investing is chaotic and tough on the stomach if you watch all the swings. If you take out the swings, you still get the same results! But you can’t in reality take out the swings, so the best thing is to try and ignore them.
I don’t want to spend my life competing against Wall Street whiz kids and supercomputer trading algorithms, so I just invest passively with rock-bottom costs. Work on your career or build a business… put your energy into something in which you have more control.
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You may be misunderstaning what I wrote:
“The lesson I take from this: It is great if you can avoid the major down days, but only if you can do so in a way that does not have you missing the major up days. If you manage to avoid all of the Worst days, but miss all of the Best days too, then your portfolio performance will be is nearly the same as straight Buy & Hold (but with additional taxes and commissions paid).”
Cool, a comment from Barry Ritholtz. 🙂
Perhaps… I took this quote “now the reality is no one will consistently miss all the worst days […] but you can avoid being long for most of a secular bear market.” as you suggesting a way to do what you wanted – miss the down days while avoiding missing the up days.
My opinion is simply that one can’t “avoid being long for most of a secular bear market”. How do you know when such a bear market begins or ends?
Have ALL those Best Days happened in a Bull Market and have ALL those Worst Days happened in a Bear Market?
Actually, most of both occur during bear markets!
There’s another way to look at this, and it’s why I keep so much money (~35%) in bonds. You can deliberately stay in the game knowing that one of these days will eventually hit, then sell your bonds and buy up any suddenly down stocks you want. That will instantly turn a “worst” day into a “best” day. You don’t have to time the market, just …sit and
wait patiently.
How many times was a worst day immediately followed with a best day…or maybe the 14th best day was after the 7th worst one? But then again the worst day might be followed by another terrible day.
That’s the flaw in Matthew’s philosophy… even after 1 bad day you still can’t time the market… it might plummet some more. Putting lots of money in bonds doesn’t help… the market often crawls up, and you’ll miss all of that if you are just waiting for the bottom to drop out.
Waiting for lots of bad days in a row to make your move? Well what if you wait too long. You might have missed the market soaring last year.
Jonathan has the right idea here. If you really want to make money you should invest your human capital resources elsewhere since playing the market is largely just gambling.
When you’ve been at this for a while you can tell pretty well when things are out of the ordinary. You should stick to a long term allocation, and stay with a value oriented approach. That said, don’t be afraid to go in big when you know that the market is wrong. It’s exactly like you said, sometimes it drops more, but more often there are big swings up on the very next day. More ups than downs historically. So you take your profit back that day and get back to your allocation. If it doesn’t work out, then you got cheaper stock either way and you can cost average from there.
Conversely, if there’s been a big pop up that doesn’t seem justified, you need to take your money and protect it. A lot of people forget to do that and get left holding the bag later on. Always consider the effect of fees and taxes beforehand.
This approach works, but it’s a waiting game. You won’t get these opportunities every day. Maybe twice a year is generous. The rest of the time you just accumulate value, collect dividends and you’ll stay in line with the market, and probably slightly better. It’s the days when they act stupid that you get really rich. I look forward to those.
Just to add some fuel to the fire, hints as to determining what will be referred to as “worst” days after the fact. Stuff to watch for are headlines like “Worst drop since 1985”, or broad events like when Germany was having debt trouble. Those are usually key times to be out buying. For example, I recently picked up Pfizer when it was at a very attractive multiple during this year’s European debt crisis. The performance since then has been pretty decent but it’s still kind of low priced so I can continue to hold it and get those nice dividends.
Maybe I’m oversimplifying things here. I just think that all the volatility lately is making it super easy to make money. The bottom line is you need to have money ready to strike when those “bad” events happen, or you’ll just roll along with it.
Knowing exactly when those spikes and dips are going to occur would be like knowing tomorrow’s lottery numbers. I guess when he figures out how to predict these spikes and dips I’ll have to buy his book :).
In 1999 I read a book called Riding the Bear by Sy Harding ( http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias%3Daps&field-keywords=the+coming+bear&x=22&y=23 )
His premise was buy and hold from around October to around March. Historically that is when most of the up movement in the market occurs. Around March go to cash because historically most of your retracements and sideways movement happens then. By doing this you are able to outperform just plain buy and hold.
Interesting and nice little book.
@Mushroom Mike,
One thing that strategy doesn’t factor in – taxes. If it’s a taxable account, you’ll need to take *at least* 15% (and probably much more) off your earnings.
The big eye opener for me is that you would have absolutely nothing to show if you would have invested $100,000 in 2000. You’d have lost an entire decade of growth.
It’s misleading to say that there was no growth because you’re only looking at the price of the index, and not any dividends paid, or the effect of them reinvested and compounding. It’s the compounding action that gets you rich, not the buying and selling of shares.
Re: Taxes (@Dave)
There is a need to focus on them (taxes) because they are an expense, but if you focus too much on taxes, you’ll never have to worry about paying them. By that I mean, having to pay taxes is a GOOD thing (it means you made money!). If you hold on to something to avoid taxes, you run the risk of not having to pay taxes. You run the risk of having a write-off.
Worry about the taxes, but don’t lose money trying to avoid paying them. I’d rather pay 15% on earnings than lose 15% of my investment.
That being said. I really hate taxes!
@Robert: Wish I could get my inlaws to see that. They have avoided selling some good gains, only to watch them evaporate because they refused to sell due to the larger tax liability. As a result they did pay less tax, but also made much smaller profits.
I completely disagree with your summary that this chart shows you should be focused on taking out the 10 best and 10 worst days, although I agree with your ultimate conclusion to just buy and hold.
What this graph shows is that buy and hold does better than any market timing strategy. There is simply no way to identify the 10 best or 10 worst days. No one can do it, no matter what they say. All these great rules of thumb provided above have dramatic examples that break the rules.
The most important thing to draw from this graph is that you must STAY IN THE MARKET to get the superior returns stocks offer. You can make your 8%+ if you buy and hold, but if you miss just 10 days in the market, and they are the wrong 10 days, you make almost nothing, and guaranteed cash returns become superior.
The bottom line is that this graph proves that market timing delivers inferior returns. (It also shows just how badly the last 10 years have sucked!)
Now, this is not to say that there aren’t sound principles NOT based on market timing that could have juiced your returns over the indices in the last 20 years. But the key is, they are not based on market timing.
Hi all – I’m the person who sent this post to Mr. Ritholtz who was kind enough to put it up on his blog (which I personally find an excellent source of information and ideas). The purpose of doing this was simply to explain WHY buy and hold works. It works because of the 10 best days explaining the bulk of buy and hold returns. Don’t focus on the 10 worst days. In the chart, the risk is not that you miss the 10 worst days (outperformance)…the risk is that you miss the 10 BEST days (significant underperformance). So buy and hold “works” because you have to be “in it to win it” given the unpredictable nature of those big up days.
I took the analysis further and put up another post on my InstaBlog on SeekingAlpha.com looking at the price history of the Dow Jones Industrial Average itself. Since 1923, if you looked at the 20 best days and 20 worst days, 32 of those days actually occur under the 200 day moving average. The implication here is that extreme days, both up and down, are more likely to occur in bear markets.
Great article. Great comments. I love it. Warren Buffett is an example how it works the best: Buy and hold. The best would be to buy today blue chip stocks. The Dow Jones is at 10.800. Stocks are still cheap. My suggestion is: Fall after you bought the stocks a sleep for the next 30 years. Wake up and you will be super rich….humans tend to panic when it goes down. And we are all excited, when it goes up. Thats why me make that stupid mistakes….buy high and sell low
I like this part the most “I don’t want to spend my life competing against Wall Street whiz kids and supercomputer trading algorithms, so I just invest passively with rock-bottom costs. Work on your career or build a business… put your energy into something in which you have more control.” I highly agree!!!! Thanks!
The most important thing to draw from this graph is that you must STAY IN THE MARKET to get the superior returns stocks offer.
Everyone can draw their own conclusion, but to me the point is simply to make the case that buy and hold “works” because of a select number of days, and that we should not get caught up in the day to day reasons for why the market is up or down. Rather, we should recognize that a small amount of days have a disproportiate impact on total returns (Black Swans effectively since the extremes are low probability but very high impact).
Buy and hold combined with regular investments with diversification is key. Even if you would have had great dividends since 2000. If you put all your cash into the S&P in 2000, you’d have done much better with a 10 year CD which where paying 7-8% APR. The S&P 2000-2010 is an entire decade of lost compounding.
@Justin: as Mr. Waterman has already pointed out, you need to look at return figures, not just index prices. But I think there are a couple of other points worth making:
1. There have been 10 year spans in the past where stocks had a negative return, and there will be some again.
2. Asset allocation and periodic rebalancing really help in this case, by forcing you to sell some of your assets that have risen and realize those short-to-mid term returns.
I’ll also note that within any 10 year span, odds favor that some asset class will make money (Gold this decade produced strong returns…as did investing in Timber during the Great Depression). The point is that when thinking about the “market” we should consider “all markets” because there are ways to produce results by looking beyond stocks.
My economics teacher was mentioning that lately with regards to mutual funds. Companies like Fidelity have for example a bunch of funds that are sector targeted, and any given year any of them could be the top performer because the market is so random. So you can’t go making your decisions on the events of just one year (Or even ten in my opinion).
The table below shows the 10 best days between over the course of the past 9 to 10 years (it’s a bit dated so it may be missing one or two of the “best days”).
Note the dates! If you managed to hold for those 10 best days, you managed to take a tremendous loss because every one of the “best days” was during the two worst bear markets in recent times.
Take a look at the chart below the 10 best days also. On average, after the close on the best days, you were still down 7.5% from 20 trading days (approximately 1 month) prior to the best day. I very….VERY…seldom catch a “best day” and I still outperform the market.
The 10 best days is just a sales gimmick for the mutual fund companies.
10 Best Days Gain
12/16/2008 5.14%
11/24/2008 6.47%
11/21/2008 6.32%
11/13/2008 6.92%
10/28/2008 10.79%
10/13/2008 11.58%
9/30/2008 5.42%
7/29/2002 5.41%
7/24/2002 5.73%
1/3/2001 5.01%
Average 6.88%
Date Of Close On Close 20 Close v. 20
Best Day Best Day Days Before Days Before
12/16/2008 913.18 850.75 7.34%
11/24/2008 851.81 848.92 0.34%
11/21/2008 800.03 876.77 -8.75%
11/13/2008 911.29 946.43 -3.71%
10/28/2008 940.51 1166.36 -19.36%
10/13/2008 1003.35 1193.75 -15.95%
9/30/2008 1166.36 1277.56 -8.70%
7/29/2002 843.43 989.82 -14.79%
7/24/2002 843.43 976.14 -13.60%
1/3/2001 1347.53 1325.05 1.70%
Average -7.55%
Sorry about the tables….they don’t copy here to well.
A bit more statistical trivia. When they say….”if you missed just the 10 best days over the past 10 years”….the implication is you missed ONLY the 10 best days and were in the market the rest of the time. How likely is that? There are about 2300 to 2400 trading days over the course of 10 years.
Feeling lucky? Pick 10 numbers out of 2400.
In one of the major lotteries, when the pot gets big, you can win $300,000,000 by picking just 6 numbers out of 59.
Again…try to pick 10 out 2400. Suffice it to say, if you can do that, you are the luckiest (or unluckiest) person to have ever walked on the face of the earth and, statistically speaking, you will likely hold that title until the earth is consumed by the sun.