Michael A. Gayed's  Instablog

It has long been said that buy and hold is a key element to long-term wealth accumulation. The idea sounds intuitive – over the long run, holding a diversified basket of stocks would have allowed investors to increase the value of their money independent of periods of expanding or contracting economic environments. Indeed there is plenty of evidence that suggests that active trading which attempts to buy low and sell high tends to over time result in underperformance.

While analysts may strongly support a buy and hold strategy, few attempt to explain exactly what it is about buy and hold investing that has made the strategy work historically. Is it a strong longer-term trend that makes buy and hold investing work historically? Or is the longer-term performance based on short-term performance spikes? To explore this, one needs to analyze historical price data. For argument's sake, let's take a look at the S&P 500 ETF (Symbol: SPY), which has been around since the early 1990s.

Source: Yahoo Finance

The blue line represents a simple buy and hold strategy of investing $100,000 in the SPY ETF (ex-dividends) since 1993 through the end of August, 2010. The investment would have grown 3x to roughly $324,000. The red line represents what the performance of that same $100,000 would have been if you assume that you were not invested in the 10 best days of performance during the SPY ETF's 17+ year history. Had you not been invested in just those 10 best days, the ending account value ex-dividends would have been a little over $156,000.

The conclusion? The 10 best days of the SPY ETF since 1993 account for over 50% of the total buy and hold performance of the fund. That's 10 days out of over 17 years. Those 10 days represent roughly 0.2% of all days holding onto the SPY ETF. So while buy and hold has been shown to beat more traditional trading approaches, the truth is that it has done so quite literally because you had to be in the market to take advantage of those unpredictable big up days. If the average investor was truly aware of this, would he or she be comfortable that half of a buy and hold performance track record is driven by just 10 days?

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Disclosure: The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing.