If you are tired of trying to time the market and get anxious when the market doesn’t move as you expect it to, consider switching to the buy-and-hold strategy. It isn’t easy to predict how a company will perform in the upcoming earnings or whether the economic data will give a boost to stocks, which is why successful long-term investors swear by the buy-and-hold strategy.
This investment approach has been successful for many, including Warren Buffett, who once famously said, “Our favorite holding period is forever” at a 1988 Berkshire Hathaway Inc. (NYSE: BRK. A) shareholder meeting.
How does the strategy work? Is it effective? We’ll answer all your questions here.
What Does it Mean to Buy and Hold?
In a buy-and-hold strategy, you purchase stocks, mutual funds or exchange-traded funds with the intention of keeping them for the long term. Unlike day and swing traders who book short-term profits, buy-and-hold investors do not sell their investments for years or decades.
They always invest with the intention of funding long-term needs. Such investors are not concerned about the day-to-day fluctuations in their investments. They expect that in the long term, the returns will be positive and they will overcome any temporary losses. This approach requires high portfolio diversification, discipline and a long-term mindset.
Advantages of Buy-and-Hold Strategy
The buy-and-hold strategy is a simple and easily understandable approach perfectly suitable for beginners. Here are a few of the advantages of this strategy.
Minimal Investing Decisions
A huge advantage of the buy-and-hold strategy is that you will have to make fewer investment decisions. Buy-and-hold investors do not need to analyze the market to make purchase and sale decisions, which makes the investment process less stressful, passive and cost-effective. It is ideal for beginners who do not have the technical knowledge and are unable to analyze stocks. You do not need to worry about monitoring the market closely. Your investing decisions will amount to reinvesting the dividends and rebalancing your portfolio.
Long-Term Success
Buy-and-hold investors are more focused on long-term success and less worried about downturns or high volatility periods. They care about the long-term growth of the investments and do not try to time the market. Buy-and-hold investors know that patience will pay off and by riding the market’s short-term ups and downs, they are focusing on the potential for long-term success.
Simplified Taxes
Regular trading can create a complex tax situation since every trade can result in a potentially taxable event. There will be different rules applied to short-term versus long-term capital gains. In contrast, a buy-and-hold strategy will simplify taxes for you. If you hold the investment for over a year, you will qualify for a lower long-term capital gains tax rate. It will not only simplify the tax filing process but will also offer tax advantages and boost long-term investment returns.
Risks of Buy-and-Hold Strategy
No investment strategy is risk-free and despite the simplicity, the buy-and-hold strategy suffers from several weaknesses.
Long-Term Market Decline
There is no guarantee that an investment held by a buy-and-hold investor will beat the market, outpace inflation or generate positive returns over time. Individual stocks will always carry the risk of market volatility, which occurs due to geopolitical concerns, management concerns, economic issues or natural disasters. This is why every investor must be prepared to stay the course through periods of underperformance and diversify the portfolio as much as possible.
Possible Missed Buying Opportunities
Since buy-and-hold is a passive strategy, it could lead to a missed opportunity to buy undervalued stocks. In contrast, active traders always analyze market trends and can take advantage of new opportunities as they emerge. Some opportunities could go unnoticed or unused and you could miss out on profits.
Inability to Benefit from Volatile Markets
Market volatility offers plenty of profit-making opportunities to active traders. They can use options to hedge their positions or go short. On the other hand, a buy-and-hold strategy with a long-only bias can endure the volatility. While you will not make immediate profits, you will maintain your position in your investment and avoid making any impulsive decisions. This will limit your ability to make profits or losses but will ensure steady growth.
Steps to Apply the Buy-and-Hold Strategy
The buy-and-hold strategy is a straightforward way of investing in the market. It focuses on accumulating assets over the long term instead of trading frequently and it is based on the belief that investments will increase in value over time, despite the market fluctuations.
Investors aim to benefit from compounding returns and overall market growth by holding assets for an extended period. This appeals to those who want a hands-off approach since it needs little management and trading. However, investors do need to conduct research and build a strong investment plan.
The following sections will outline the key steps for successful implementation, including selection criteria, timing considerations and portfolio management strategies.
Step 1: Research and Select Investments
Research assets that have strong fundamentals, a solid business model and the potential for long-term growth. Look for companies that have shown consistent earnings and stability and possess a competitive edge in the industry.
Step 2: Create a Diversified Portfolio
Diversify your investments to reduce risk. Spread the investments across different asset classes or sectors like stocks, bonds or real estate to reduce the possibility of potential losses. This will keep your portfolio balanced if one investment doesn’t perform as expected.
Step 3: Plan Your Entry Point
Figure out the best time to buy the assets. Market timing can be challenging and might not always be accurate. You can benefit if you buy stocks during market dips or when you feel the asset is undervalued. Set clear price targets to guide you in making decisions.
Step 4: Hold for the Long-Term
Once you’ve made your investments, do not respond to the short-term market changes. Focus on the long-term growth potential and stick to your strategy. Steer clear of the temptation to time the market and make quick profits.
Step 5: Monitor and Reassess Your Portfolio
Remember to check your portfolio to ensure your investments are aligned with your financial goals and the market situation. If needed, reallocate the assets or sell the investments that aren’t performing well. Continue to focus on the overall buy-and-hold strategy.
Passive vs. Active Management
There are two practices of investment: Active and passive. A buy-and-hold strategy is a passive form of investing since it has a long-term focus, infrequent trading activity and does not need regular research and portfolio management. On the other hand, active management involves frequent buying and selling and regular trading.
Labeling the buy-and-hold strategy as a passive form of investment should not be misunderstood as a set-it-and-forget-it approach. It does not need constant analysis typical of active management but it is still important to review your portfolio regularly. It also includes rebalancing the portfolio, dividend reinvestment and evaluating the performance of the investments against your long-term goals so as to make the necessary adjustments as and when needed. Occasional intervention will help ensure that your portfolio remains aligned with your risk appetite, financial goals and the life stage you’re in.
Buy-and-Hold Strategy: A Timeless Approach to Investing
A simple, time-tested approach, the buy-and-hold strategy focuses on having a long-term mindset. It offers tax simplicity, the potential to enjoy higher returns and does not require frequent trading. It does carry risks like missed buying opportunities but the long-term growth can make up for it.
To successfully apply this strategy, choose diversified investments that have low fees and match your risk appetite. Whether you are a beginner or a seasoned market investor, the buy-and-hold strategy can be a powerful tool, offering a steady approach to long-term growth. You need to remain disciplined and stay the course, no matter the market movement. If you can learn to cope with volatility, a buy-and-hold strategy will succeed.
Frequently Asked Questions
Is the buy-and-hold strategy risky?
Buy-and-hold is a low-risk strategy that favors investors who have a long investment horizon. It does come with risks but these risks are lower than those brought by frequent trading. The only disadvantage of the buy-and-hold strategy is that it will tie up your capital for the long term. Diversification is one way to protect yourself from risks.
Why does Warren Buffett recommend a buy-and-hold strategy?
Warren Buffett invests for the long term and follows the value investing strategy, where he focuses on buying undervalued companies with strong growth potential and holding them for the long term.
How to start with the buy-and-hold strategy as a beginner?
The first step is to identify your risk appetite and research stocks that align with the risk you can take. You might want to seek the help of a professional expert to research stocks. Look for undervalued stocks and hold them for the long term. Do remember to evaluate the performance of your assets at regular intervals.
About AJ Fabino
AJ Fabino is the Investing & Cryptocurrency Editor at Benzinga, overseeing a range of financial content, including stocks, ETFs, options, mutual funds, futures, IPOs, bonds, and cryptocurrency. With extensive experience in financial journalism and content strategy, AJ is dedicated to delivering engaging, insightful, and timely news that empowers readers to make informed investment decisions.
