Buy and hold: The power of the compounded effect

Imagine your child is born 25 years ago and inherited $10,000 in Apple stocks from a wealthy uncle. Could you envision your kid owning $7 million by age 25?

A highly effective strategy for investing in the stock market involves adopting a “buy and forget” approach. This approach eliminates the stress associated with monitoring market fluctuations, as investors are not required to regularly assess the performance of their investments. While this strategy may not provide immediate returns, it can still yield substantial long-term benefits due to the compounding effect of growth. 

Buying and holding is also an excellent way to invest on behalf of your children until they are capable of making their own investment decisions. 

Let’s use some numbers to make this clearer. On average, the S&P 500 doubles its value every 7 to 9 years. If you’re not into taking risks, you can buy and hold money in the S&P index, and you’ll double your money in less than 10 years. Not bad.

So, if 25 years ago you had invested $1,000 in the S&P 500 index, and you did not touch it, you’d now have $7,500! That’s a pretty impressive return, right? It’s all thanks to this index doubling almost three times over the past 25 years. 

For investors with a higher risk tolerance, the choice of investing in an index is not always the best. Actually, the primary objective of an active stock investor is to outperform the S&P 500. To achieve this, it’s more effective to focus on individual stocks that have the potential for faster growth compared to the index itself. Higher risk, higher reward, or higher disappointment?

For instance, a successful example from the real world: Over the past 25 years, Apple stock value has doubled every 2.6 years. This is a lot faster than the 7 to 9 years to double from the S&P 500. To illustrate the magnitude of this growth, imagine investing $1,000 in Apple stocks 25 years ago. Today, those same stocks would be worth a staggering $700,000. 

This was the case of my friend Peter. He got a surprise bonus at work 25 years ago, and he followed my advice to invest it all in the stock market. We were blown away by the impact that PCs were having in our lives, so I counseled him to invest his entire bonus in Apple stocks. Not even in our wildest dreams of fortune, did either of us remotely imagine that we were essentially securing the college funds for his two daughters, who would be born a few years later. 

The success factors behind this case study include a combination of market trend understanding, company assessment, a higher-than-average risk profile, the flexibility to change investment strategy, and, candidly, good fortune:

• To start, we chose the right stock that significantly outperformed the S&P 500. The two fiercest competitors in personal computing, the newest invention and one of the hottest market trends at the time, were IBM and Apple. Had we chosen IBM instead, the same $1,000 investment would have only turned into $3,800. IBM doubled its value about twice in 25 years, roughly every 13 years. 

• Also, a crucial aspect of this story in retrospect is the “hold” or “forget” approach. In full disclosure, this wasn’t necessarily part of my recommendation to Peter as I was becoming quite an active trader, but he chose not to “care” about the evolution of his investment. His reasoning was that the money he had decided to invest was a “surprise” bonus that he hadn’t anticipated. He was also content with the idea of setting it aside, not even dare to look at it over time. He ultimately became the textbook ideal example of how a buy-and-hold strategy can be extremely effective. 

Let’s revisit the idea of investing on behalf of your children: Instead of relying solely on a 529 plan, consider the idea of allocating a portion of your savings to specific companies and gift it to your children at each of your child’s birthdays. This could be $1,000, $2,000, or even $10,000 every year, depending on your financial situation and the amount you can set aside for their education. 

Each year, you’ll have the opportunity to choose the company that you believe has the potential for the most growth. 

Perhaps in some years, you’ll end up selecting “an IBM,” while in others, you might opt for “an Apple”. If over the first 5-10 years of your child’s existence you invest in one of those years in a company with a growth like Apple had in the last 25 years, then your children will reap the benefits of an accelerated and compounded effect of investments over the years. This will result in accumulating sufficient wealth for their college education.

Now, to take this even further than just saving for college, consider the hypothetical scenario where your rich uncle gave you at birth a gift of $10,000 in Apple stocks. Do you imagine yourself accumulating $7,000,000 by the age of 25?

Your child might not have a wealthy uncle, but there’s still an easy way to help them save for college. And when they reach a certain age, you can involve them in choosing the company to invest in for their birthday. This is a very effective way to introduce them to the world of trading. 

As a final note, here’s a concise summary of the calculations in this case study. A $1,000 investment made 25 years ago in three different scenarios:

Invest $1,000 in the S&P 500 Index:

• Annualized Total Return: ~8.4%

• Future Value: ~$7,500

• Doubling Frequency: About 2.9 doublings over 25 years. Average doubling time ≈ 8.6 years. 

Invest $1,000 in Apple (AAPL):

• Annualized Total Return: Roughly 30% (with dividends reinvested)

• Future Value: ~$700,000

• Doubling Frequency: Approximately 9.45 doublings over 25 years. Average doubling time ≈ 2.6–2.7 years. 

Invest $1,000 in IBM:

• Annualized Total Return: ~5.5%

• Future Value: ~$3,800

• Doubling Frequency: About 1.93 doublings over 25 years. Average doubling time ≈ 13 years

Simon Benarroch

Ockham Finance founder