8 min read Strategies

Strategy: Buy & Hold the Index (US Markets)

Strategy: Buy & Hold the Index (US Markets)

Click here for the version for Canadian markets

Overview

  • This long-term strategic asset allocation strategy holds a single (or small set of) passive index ETFs.
  • The goal is to capture the overall market’s rate of return, thus outpacing inflation.
  • ETFs are preferred over mutual funds to reduce unnecessary fees (which improves returns).
  • This strategy is the most straightforward possible long-term investment strategy, yet it will outperform most investors and mutual funds—if you can’t beat the index, own the index.

Variations

Option #1: Buy S&P 500

Owning the S&P 500 Index is the most accessible place to begin, especially if you’re new to investing. It has a long record of solid performance over the past 100 years (9.5%+ annualized, 6.5% after inflation). Indexes regularly cull weaker companies and replace them with stronger ones, so you’ll always own healthy, financially stable companies, which makes this a very safe long-term strategy.

Rules

  • Buy & hold the S&P 500 Index ETF (symbol SPY).
  • Contribute regularly, ideally at least quarterly (contingent primarily on transaction fees).

Strengths

  • Tax efficient—no ongoing capital gains, just 2%–3% annual taxable distributions (if not held in a tax-sheltered account).
  • Strong long-term performance.
  • Simple and easy—can be fully automated.
  • Scales from small to large accounts.

Weaknesses

  • There is timing risk if making a single large contribution (from cash rather than switching from similar investments), especially when first starting—use dollar cost averaging when possible.
  • Occasional large drawdowns (30%–50%)—but these are normal and expected and are a net benefit rather than liability over the long term.
  • Concentrated in US equities—which is not a problem to worry about initially but not ideal for larger accounts (e.g. more than $100K).

Option #2: Buy S&P 500 with market timing

As I described elsewhere, timing the market is not only possible but tactically sound. I’ll use the same market filter here—holding only when the monthly closing price is above the 200-day simple moving average (SMA200). When selling, you can choose to sell 100% of your position or some fraction, depending on your goals—the primary consideration would probably be taxes. For example, if you know you’re going to need some of your money in the next few years (e.g. during retirement) when signaled to sell, you could sell enough of your portfolio to meet your needs for several years, which would significantly reduce the chances of being forced to sell at market lows.

Rules

  • Buy & hold the S&P 500 Index ETF (symbol SPY).
  • If still saving (i.e. before retirement), contribute regularly, ideally at least quarterly (contingent primarily on transaction fees).
  • Sell and stop contributing when the month-end price <= 200-day simple moving average (SMA200).
  • Re-enter fully and resume contributions when the month-end price is > SMA200.

Strengths

  • Significantly reduces drawdowns compared to Option #1.
  • There is much less timing risk for lump sum contributions or withdrawals.

Weaknesses

  • Much less tax efficient—can generate sizable long-term capital gains every few years (if not held in a tax-sheltered account).
  • It requires monthly monitoring—you can’t set it and forget it.
  • It will likely slightly reduce returns compared to Option #1 over the long term.

Option #3: Buy 60/40 Portfolio

This well-known portfolio divides your money into 60% stocks and 40% bonds. Some other common splits are 80/20 or 40/60. The main attraction of bonds is they are less volatile than stocks (about half), and their performance is often uncorrelated to stocks. This can be an advantage over the shorter term (less than ten years) because it can reduce the size of your drawdowns. But over the long term, bonds do not mitigate risk; they reduce returns.

Rules

  • Buy & hold 60% S&P 500 Index ETF (symbol SPY) and 40% Aggregate Bond ETF (symbol AGG).
  • If still saving (i.e. before retirement), contribute regularly, ideally at least quarterly (contingent primarily on transaction fees).
  • Rebalance regularly (annually is sufficient) to the desired allocation, ideally buying more of the laggard with new contributions rather than selling the winner (if not held in a tax-sheltered account).

Strengths

  • Tax efficient—no ongoing capital gains except if selling is necessary to rebalance, just 2%–3% annual taxable distributions (if not held in a tax-sheltered account).
  • Simple—no decisions to make.
  • Less volatility than Option #1.

Weaknesses

  • There is timing risk if making a single large contribution (from cash rather than switching from similar investments), especially when first starting—use dollar cost averaging when possible.
  • Guaranteed lower performance over the long term—not a good long-term strategy compared to Option #1.
  • Bonds are not risk-free, as shown by the 25% drawdowns in 2021–2022.

Performance

Since Inception, Jan 1994–Dec 2023

Note: since AGG started trading in 2004, alternate data has been used to backfill pre-2004.

S&P 500 S&P 500
with market timing		 60/40 Portfolio
Starting with $10,000 $176,014 $169,593 $102,790
Annualized Return 10.0% 9.9% 8.1%
Rolling 5-Year Annualized Returns
(worst / best)		 -2.4% / 28.5% 3.3% / 23.4% 0.8% / 20.2%
Maximum Drawdown (EOM) -50.8% -23.0% -32.3%
Maximum Drawdown
Length in Months		 74
(2000–2006)		 37
(2000–2003)		 40
(2000–2003)
Best Month 12.7% 10.9% 8.3%
Worst Month -16.5% -14.1% -10.8%
Average Month 0.90% 0.84% 0.69%
% Positive Months 65% 76% 66%
Best Year 38.0% 38.0% 31.3%
Worst Year -36.8% -21.0% -21.1%
% Positive Years 79% 72% 79%
Average # of Trades Per Year 0 1.3 1
Annualized Return using DCA 9.6% 8.9% 7.9%
Safe Withdrawal Rate (25 years) [coming soon]

Take note of the variability in the range of 5-year rolling returns. This helps quantify the timing risk involved with significant lump-sum contributions.

Buy S&P 500 vs. Market Timing vs. 60/40 Portfolio, logarithmic-scaling, growth of $10,000, $0 transaction fees

Portfolio Considerations

Taxes — If investing outside a tax-sheltered account:

  • Option #1: Buy S&P 500 — Very tax efficient. Only expect to generate capital gains when selling in the distant future.
  • Option #2: Buy S&P 500 with market timing — Moderately tax efficient; most suitable for tax-sheltered accounts. Can generate significant long-term capital gains every few years.
  • Option #3: Buy 60/40 Portfolio — Very tax efficient; will sometimes have small long-term capital gains when rebalancing, but most capital gains will be in the distant future.

Contributions — The timing of contributions is largely unimportant—ideally, you’re using dollar cost averaging. However, there are significant timing risks with lump-sum contributions. It is better to spread out disproportionately large one-time investments into quarterly contributions over two years.

Withdrawal — Large unplanned withdrawals are possible but negate the primary benefits of this strategy: tax efficiency and being unaffected by volatility. Small planned or ongoing withdrawals are fine.

Minimum Account Size

  • $1,000 — if using a zero-commission broker (less if the broker allows fractional shares or if you’re using an index mutual fund)
  • $5,000 — if your transaction cost is $9.99 (ideally, you want to pay less than 1% commission per contribution).

Diversification — The S&P 500 index is well diversified across market sectors but is concentrated in the US economy. When first starting, this is not a significant problem. Once you have a more extensive portfolio (e.g. more than $100K), you can consider diversifying geographically. The 60/40 Portfolio adds bonds as an additional asset class to reduce short-term volatility, but over the long term, they reduce returns.

Effort

  • Option #1: Buy S&P 500 — Almost none. You should be able to set up an automated recurring contribution.
  • Option #2: Buy S&P 500 with market timing — Some. You’ll need to check your positions monthly and potentially act when markets enter (or exit) a bear market.
  • Option #3: Buy 60/40 Portfolio — Almost none. You should be able to set up an automated recurring contribution but may need to manually rebalance annually.

Timeframe — The minimum period to hold to reduce timing risk:

  • Option #1: Buy S&P 500 — Minimum 10 years.
  • Option #2: Buy S&P 500 with market timing — Minimum 5 years.
  • Option #3: Buy 60/40 Portfolio — Minimum 7 years.

FAQ

Why own the S&P 500 Index?

The reason to own the index is the adage, “If you can’t beat ’em, join ’em.” Most investors underperform the index. Are you one of them? Probably. The S&P 500 is specifically well-diversified across all the economic sectors and has had excellent historical performance. If you could buy the index and stop underperforming the markets, why wouldn’t you?

Why so simple? Why only hold one fund?

Why not? Prove to me that complicated is better. The S&P 500 Index holds 500 different companies. Why is that not enough?

If you have a more extensive account (e.g. more than $100K), owning additional funds for diversification reasons (e.g. geographic) can make sense. But you don’t need 20 different funds—a handful is sufficient. It is important to select additional funds that are not strongly correlated (because they invest in similar assets)—otherwise, they will not decrease your volatility or risk.

If you’re a more advanced investor, you can add alternate asset types once you’ve constructed your core portfolio. Or use some more advanced tactical strategies to increase returns and decrease drawdowns. But don’t feel you need to. If you hold meaningful retirement savings in passive index ETFs rather than expensive mutual funds, you’re already ahead of most people.

Why use SPY and not IVV, VOO, or SPLG?

I use SPY in my analysis because it has the most historical data (starting in 1993). But all these funds are essentially interchangeable today.

Which strategy is the best choice for me?

It depends on how you plan to construct your portfolio and your timeframe. But in terms of the critical differences between these three strategies:

  • Option #1: Buy S&P 500 — the best default strategy for savers. It will have the best long-term returns (worst case, average case, and best case), especially with dollar cost averaging.
  • Option #2: Buy S&P 500 with market timing — better short-term worst-case returns than Option #1. So, if you’re spending rather than saving (i.e. retired), it has a higher safe withdrawal rate.
  • Option #3: Buy 60/40 Portfolio — has worse returns than Option #1 and worse drawdowns than Option #2. However, it is more tax-efficient than Option #2, which can be helpful for money held outside a tax-sheltered account during retirement.
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Disclaimer: We are not licensed financial advisors and cannot advise individual investors. This is not an endorsement to buy or sell any particular security. Do your own due diligence, use your best judgment when choosing investments, and only select risks appropriate to your risk tolerance. Consult a licensed financial professional if you have questions about your financial situation. We attempt to ensure the accuracy of the information presented, but we cannot guarantee that accuracy. All investing involves risk, including losing the money you invest. Past performance does not guarantee future performance. We and our families invest in these strategies (because we believe they are the best way to invest), and therefore, we may own most of the assets described herein.