Like Ulysses, a HODLER is countering emotional impulses to act in a potentially self-destructive way by tapping into an equally strong emotional impulse not to act at all.
In this sense, HODLING could be seen as rationally irrational.
Committing to the long-term
There are many different approaches to the stock market. We are open-minded when it comes to different ideas and strategies.
There is abundant evidence, however, that simply owning a diversified portfolio of stocks works out quite well over long periods of time.
Over the last 20 years, for example, the S&P 500 has delivered a compounded annualized rate of return close to 13%.
There is also a lot of evidence that market-timing strategies are difficult if not impossible to execute successfully over long periods of time.
A lot of people out there predict market tops and bottoms… but very few consistently get them right.
Buying and continuously holding a diversified portfolio of stocks, either through funds or individual stocks, therefore makes a lot of sense.
Investors can benefit from the long-term upwards trajectory of stocks by establishing what can be thought of as an almost permanent foundation of stock market exposure.
Funds, especially passively managed index funds, are an excellent place to start when it comes to building the base of an investment portfolio.
Investment portfolios can and should evolve over time. But by establishing a solid base, and sticking with it through thick and thin, investors can essentially lock in the benefits of long-term stock ownership.
The ETF Solution
Exchange Traded Funds (ETFs) have become extraordinarily popular as an easy and low cost way to get exposure to the stock market as well as other asset classes like bonds and commodities.
One of the nice features of ETFs is tax efficiency.
Although active ETFs are increasingly getting rolled out, the vast majority of ETFs today follow passive strategies, which means they simply track the holdings of a reference index.
For example, the largest ETF is the SPDR S&P 500 ETF Trust (SPY), which has over $600 billion in assets. It tracks the S&P 500 Index.
Even though the composition of most ETFs is continuously changing to stay in line with the reference index, these changes generally do not create taxable capital gains realizations.
Through a process known as “in-kind” redemption and creation of shares, taxable gains are avoided when funds managed by ETFs grow, shrink or get rebalanced.
This mechanism is one of the main reasons that stock ETFs can be such an attractive vehicle for long-term saving.
ETFs are able to evolve with changes in the market, but this internal buying and selling activity generally does not create a taxable event. ETF investors are therefore able to defer capital gains realizations until they sell their shares.
Long-term HODLERS of ETFs can potentially defer gains for decades.
They may even pass the investment onto their heirs, who under current law may be able to avoid capital gains liability altogether through the concept of a stepped-up basis at inheritance.
Core versus Satellite
Fund management companies and financial advisors sometimes describe fund options using the “core/satellite” framework. It’s a useful metaphor.
Core funds should be highly diversified and offer broad-based exposure to the stock market. They warrant large allocations within a portfolio.
Satellite funds are narrower in focus but can be complementary to core funds.
Satellite funds should be used to take advantage of more specific opportunities or scenarios. They require smaller allocations.
Core Stock ETFs
An investor building a portfolio from scratch has many options when it comes to core funds. The goal here, again, is broad-based exposure.
