It’s Compounding, Not Buy-and-Hold Investing, That’s Your Path to Great Wealth

James Deporre

When most people think of building great wealth in the stock market they picture Warren Buffett. Find a great stock, hold it for the very long-term, and the power of compound growth will make you rich.

The math is inevitable and it sounds rather easy but the difficulty of finding a great stock to hold for decades is grossly underestimated. It is always simple in retrospect. We just look back and see how holding Apple (AAPL), Microsoft (MSFT), or Amazon (AMZN) for years was an easy way to produce great wealth. The much more difficult question is what are the equivalents in the decades ahead? There is nothing tougher in investing than finding the next Apple or Amazon. Even Buffet himself has said that only a handful of such opportunities occur in a lifetime.

What we very seldom hear much about is the great risk of long-term buy-and-hold investing if you pick the wrong stocks. No one talks about the ‘great’ stock that they held for years before they figured out it simply wasn’t anything special. The cost of doing this is tremendous. You may not suffer any actual loss but you will incur very high ‘opportunity cost’ which means that your account has not been compounding. Opportunity cost is what you pay when you pick a stock that is not going up.

It is easy to overlook how compounding really works. Most people think it only applies to holding a single asset for the long term. That is one way to use this power and it works great if you pick the right asset. Another way is to focus on keeping your account close to highs rather than the assets that you hold. It doesn’t really matter what you own at any particular time as long as you keep finding profitable trades and investments.

The power of compounding is much more a function of money management than anything else. It certainly helps to pick the right investments but what is more important is that there is steady upward progress in your account. You could own a different stock every day and as long as your account is gaining ground you will benefit from compounding.

One of the problems that traders and investors run into eventually is that it becomes increasingly difficult to keep your money fully invested in the most productive trades and investments. Someone like Warren Buffett has to stick with big core positions, otherwise he will never be able to put his cash to work.

The biggest challenge you will find in harnessing the power of compounding is finding the right vehicles for your precious cash. I believe that you can find more ways to produce account growth if you use a shorter-term approach rather than roll the dice on holding a few big positions for years.

To build great wealth focus on keeping your accounts near their highs. That is how you harness the power of compounding. There will be times when you have drawdowns and don’t make much progress but if you avoid the highly unproductive work of recouping large losses you will have amazing results.

Picking a great stock for the very long term is a fantastic way to get rich but it is extremely difficult and carries high risk. Account management that focuses on keeping your account close to highs requires hard work but it is less risky and can reap even better results if you are an astute stock picker and use disciplined account management.