Myth #1: "Buy and Hope"

Summary: Wall Street brokers continue to perpetuate the myth of “buy and hope” and they continually preach that the market will always rise over time.  In truth, drastic drops in the market are inevitable and the average investor can’t afford to lose. Principal protection should be the number one component of any investment strategy.  

The Facts: Crestmont Research, a hedge fund data research firm founded by prolific author Ed Easterling, completed a fascinating study on the true impact of a “buy and hold” approach. “Whereas the 'relative return' investor (tracking stock market indexes) will generally experience 100% of the downside and 100% of the upside to achieve market returns, the 'absolute return' investor only needs a fraction of the upside when downside losses are limited.” Specifically, over the course of 50 years, if one could avoid all down years, one would only need to participate in 25% of the gains to match the “buy and hold” approach.

The point is, if you can always preserve principal and avoid taking part in market losses, you don’t need to take the risk that most buy/hold investors must take.

The Real World: From 2000 to 2003 the market went down 38%. But from 2004 to 2007 the market rocketed up 83%.   Financial planners highlight this performance to lead you to believe that you would have missed out on these massive gains had you not “bought and held.” Lets look at this in more detail (see chart below).  If you had invested $100,000 on day one of 2000, by the end of the 2003 your account balance would be $62,000 (or down 38%).   Then by the end of 2007, your account has grown by 83% so your new account balance is a whopping $113,460. So when all is said and done, your average return over the course of the 7 years period was 1.92% annually.