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The correctness of the buy and hold strategy can appear to be confirmed by a chart of just about all shares that have been quoted for a 15-year period on the London stock market. As just one example, the chart of Grand Metropolitan is shown in Figure 1.1. Taking the extremes of the chart, an investor could have bought Grand Met shares at 52p on 6th January 1978 and sold them on 31st January 1995 at 464p. If dealing costs are ignored, this represents a profit of 412p per share, i.e. a profit of 792% on the initial price.

Figure 1.1 The Grand Metropolitan share price since 1978

Unfortunately, dealing costs cannot be ignored, and the small investor suffers more than most as far as the level of costs is concerned. For the sake of argument, if we assume that a parcel of 1000 shares was purchased at 52p, then the dealing costs on such an amount would be approximately 2.5%. The selling costs would be approximately 1.5%. These percentages increase rapidly as the value of the deal falls below £1000 and decrease only slowly as the deal moves into the tens of thousands of pounds.

Thus the dealing costs of buying 1000 shares at 52p would be about £13 and the selling costs of selling at 464p would be about £69. Now we can calculate a more realistic profit for the entire deal than the 792% we noted above:

Buy 1000 shares at 52p Outlay = £520 + £13 = £533

Sell 1000 shares at 464p Receipts = £4640 - £69 = £4571

Actual gain = £4038

This represents a gain of 757% on the outlay of £533. Therefore the dealing costs of this transaction have reduced the overall gain by some 35% over the 18-year period.

If we are going to make this a realistic exercise, then there is one important aspect that is missing from this calculation. This concerns the dividends that would have been paid during the 18-year period for which the shares would have been held. To simplify matters, we can consider that Grand Metropolitan consistently paid a 5% dividend, year in and year out over this period.

Since the average share price was halfway between 52p and 464p, i.e. 258p, we can estimate the cumulative dividend as:

18 x 1000 x 258p x 5% = £2322

This increases the actual gain from £4250 as calculated without dividends to £6572 with dividends. This now gives a gain of 1233% on the initial outlay of £533.

Since we require some standard timescale over which to compare the gain from one situation with the gain from another, it is best to state this gain from investment in Grand Metropolitan shares as a percentage gain per annum. As we discussed above, it is not correct simply to divide the 1233% by 18 and use this as the annual gain. The annual gain has to be such that it compounds into a gain of 1233% over the 18-year period, so that we could compare it with that made by an investor who leaves his money and the accumulated interest in an interest-bearing account. If we do this, we find that the gain of 1233% equates to a gain of 15.5% per annum. This is superior to any gain that could have been made by depositing the money in the money market for one-year periods, year in and year out, and so appears to verify that long-term investment in shares is an excellent strategy.

The profit from the position is made because the share price has risen more than sufficiently to offset the buying and selling costs and we have had the advantage of a number of dividends over the time period.