Warren Buffett has been described as the most successful investor of the 20th century and one of the world’s wealthiest and most influential people. Each year since 1965 he has published his annual letter to shareholders, a document considered by many fund managers to be investment gospel.
He wrote in his 1993 letter “By periodically investing in an index fund the know-nothing investor can actually outperform most investment professionals.”
Investing is one of the few things in life that the less you do the better you end up. The premise of a buy and hold strategy is that share markets tend to rise in the long term. Rather than obsessing over which ETF or stock will be the next big thing, a more appropriate strategy is to buy a diversified portfolio, leave it alone, and to hold it indefinitely.
Study after study shows this type of investing has done better than active trading strategies. We’ve written about many times over the years including in Why you wont beat the market.
In 16 of the past 20 years, the Australian share market has posted a positive return.
Another common strategy to complement the buy-and-hold is to dollar cost average where you buy into the market at regular intervals.
Over the last 50 years, the long term average return on the Australian share market is 9.1% per year including dividends. This includes a few negative years. Had you invested $10,000 in 1970, the value of that in 2020 would be $803,897. That’s the magic of compounding, having your dividends reinvested, and staying put over the long term. Check out our investment calculator to see it for yourself.
Why do buy-and-hold strategies outperform? Every time you trade, you incur costs such as brokerage and tax. The reason active buying and selling underperforms a buy-and-hold strategy is because these increased transaction costs eat into your returns. Even the Australian Taxation Office (ATO) encourages you to hold assets for longer periods of time, providing capital gains discounts.
Why ETFs can be used for buy-and-hold investing
Better investing is done on autopilot. Fewer headaches, fewer decisions, and fewer costs. ETFs provide a great long term vehicle that investors can use to implement their buy-and-hold strategy.
Top 5 tips for buy-and-hold ETFs:
- Good level of size – ETFs that don’t grow fast enough can shut down. It’s important to pick ETFs that have ample asset size (ideally $50 million plus) to avoid this risk.
- Low fees – the less you pay, the more return is left for you. Higher ETF fees are a drag on long term returns, so it’s important to find low cost ETFs (ideally less than 0.20% p.a.).
- Track record of index – all index ETFs track a market index, but some indices have not been around for very long. Choose ETFs that have well established track records over many years.
- Long term history of good performance – rather than looking at the monthly performance, focus on the long term returns over three, five and ten years.
- Liquidity and spreads – while not the most important consideration for buy and hold investors (given there is minimal transactions taking place), when choosing your ETF, choose an ETF with low spreads that is highly liquid.