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I was recently reading Roger Nusbaum's "The 100% Yield Idea Makes No Sense," and I came across this comment from A Seeking Alpha user that derided the practice of holding conservative blue-chip stocks indefinitely:

Large Cap Good Dividend Stocks to Hold Forever. Pennsylvania Railroad . United States Steel. Bethlehem Steel. General Motors. WR Grace. Enron. MCI WorldCom. Trans World Airlines. Pan American Airlines. Eastern Air Lines. Baldwin Locomotive Works. First National City Bank of New York. The Bank of America. Federal National Mortgage Association. Federal Home Loan Mortgage Corporation. Lehman Brothers. E.F. Hutton and Company. Radio Corporation of America. Western Union. The Erie Canal Company. Reading Railroad.

The point, presumably, was to point out that many companies that appear to be "safe" and "conservative" blue-chip stocks today may no longer be here tomorrow, and therefore, the notion of holding companies indefinitely is likely a fool's mission because the investing landscape can change so fast in unpredictable ways that the thought of experiencing ever-growing growth from a blue-chip holding is naïve at best.

Here's my response. My favorite quote from President Abraham Lincoln is this: "The best thing about the future is that it happens one day at a time." That's true with long-term investing as well. It happens one day at a time. If you watch a company and see that it is experiencing slowing earnings growth and dividend growth over a three-to-five period, it may be time to consider an alternative investment. Although some companies, such as Wachovia, can fall apart rather quickly, many companies give warning signs that the business model is deteriorating. It's probably fair to say that Kodak shareholders had a roughly ten-to-fifteen-year period to realize that the economics of the business were crumbling, and it was probably time to sell the shares if they were held in an account intended for long-term investments.

The other preliminary response I would offer is that certain kinds of failure are more predictable than others. Some sectors do not lend themselves to buy-and-hold investing. Tech companies are notorious for rising and falling, financial firms seem to experience a major catastrophe every generation or so, and any product that is realistically subject to some kind of technological obsolescence (i.e. a newspaper) may be worth avoiding altogether.

But here's the best news of all: if you're diversified across twenty to thirty blue-chip holdings, you can handle some big failures along the way and still build some significant wealth. For illustrative purposes, let's say that someone alternates between making a sound blue-chip investment and a bankrupt blue-chip investment every year between 1990 and 2006. By the way, this would be a catastrophic personal record. If every other investment that you make goes bankrupt, that is one of the strongest signals I can imagine that index fund investing might be the way for you to go. Nevertheless, let's look at what happens when we combine the forces of compound interest with gawd-awful stock picking.

  • 1990. Our investor puts $10,000 into Procter & Gamble (NYSE:PG). That money compounded at a rate of 11.12%, and is now worth $107,000.

  • 1991. Our investor puts $10,000 in Pennsylvania Railroad. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 1992. Our investor puts $10,000 into Coca-Cola (NYSE:KO). That money compounded at a rate of 8.42%, and is now worth $52,000.

  • 1993. Our investor puts $10,000 into Bethlehem Steel. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 1994. Our investor puts $10,000 into Colgate-Palmolive (NYSE:CL). That money compounded at a rate of 14.29%, and is now worth $118,000.

  • 1995. Our investor puts $10,000 into Enron. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 1996. Our investor puts $10,000 into Johnson & Johnson (NYSE:JNJ). That money compounded at a rate of 8.93%, and is now worth $41,000.

  • 1997. Our investor puts $10,000 into Eastern Airlines. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 1998. Our investor puts $10,000 into Altria (NYSE:MO). That money compounded at a rate of 15.46%, and is now worth $80,000.

  • 1999. Our investor puts $10,000 into Radio Corporation of America. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 2000. Our investor puts $10,000 into The Southern Company (NYSE:SO). That money compounded at a rate of 13%, and is now worth $51,000.

  • 2001. Our investor puts $10,000 into The Erie Canal Company. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 2002. Our investor puts $10,000 into Exxon Mobil (NYSE:XOM). That money compounded at a rate of 10.22%, and is now worth $27,000.

  • 2003. Our investor puts $10,000 into General Motors. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 2004. Our investor puts $10,000 into General Mills (NYSE:GIS). That money compounded at a rate of 9.89%, and is now worth $22,000.

  • 2005. Our investor puts $10,000 into Lehman Brothers. Let's assume our investor got completely wiped out and turned his investment into $0.

  • 2006. Our investor puts $10,000 into Abbott Labs (NYSE:ABT). That money compounded at a rate of 10.07%, and is now worth $18,000.

So where would our hypothetical investor be today? Well, he would have invested a total of $170,000 over a sixteen-year period. Eight of those investments are assumed to turn $10,000 into $0 (Nota Bene: the bankruptcy investments are for illustrative purposes only. For instance, Pennsylvania Railroad actually filed for bankruptcy in June 1970. The take-away point is that the odd-numbered year investments carry the assumption of turning a $10,000 investment into $0). Yet, the blue-chip investments managed to turn $170,000 into $516,000. Considering that we're assuming that this buy-and-hold investor is effectively throwing almost every other dollar down the drain, those aren't bad results.

Long-term investing does not need a 100% success rate to create meaningful wealth. A few successful investments over a fifteen to twenty year stretch can more than offset some substantial losses along the way. It's easy to blast long-term investing on the premise that some companies become shells of their former glory. The good news for us as investors is that we can take initial precautions (staying away from banks and tech companies) to remove a large part of that risk in the blue-chip universe, and we can monitor all of our holdings for signs of earnings growth deterioration. But even if we fail to do that, the above example demonstrates that significant wealth can still be accumulated even when a buy-and-hold approach is practiced with a terrible execution.

Source: Why Blue-Chip Stock Failure Is Tolerable