The buy and hold investing strategy is essentially just what it sounds like: Purchase stocks and then hold them for an extended period of time. The underlying assumption for the buy and hold strategy is that stocks tend to go up in price over extended periods of time. Research supports this trend in a growing capitalist economy and the strategy has made millions rich.
There is also something to be said about not having to ride the emotional roller coaster with every increase and dip in the market…just buy the stock and check on it once in awhile.
Is the buy and hold strategy right for you?
- You are investing with long term goals in mind?
- You are unlikely to need the additional cash on short notice?
- You would like to reduce commissions and other fees?
- You would like to reduce or defer taxes?
If you answered “yes” to any of the above, then a buy and hold strategy might be a good fit for at least a portion of your portfolio.
A Buy and Hold strategy is a traditional long-term investment strategy of buying a stock long and holding on to it for an indefinite period of time, usually 3-5 years. This classic strategy is associated with a bottom-up investment management style where the portfolio analyst uses the financial statements to forecast growth in earnings and buys the stock long-term, anticipating growth and therefore price appreciation for the stock over a period of time.
Buy and Hold strategies are most often strategies used with registered non-taxable accounts, such as a 401k or IRA’s, where the manager is limited to long only positions and does not have the ability to use derivatives or to sell short stock.
For example, after extensive research and due diligence, a portfolio manager learns that a new small-cap company, Stock Group, has some earnings and is expected to be a leader in their industry. The portfolio manager decides that this is a potential great investment and sees good growth for the firm in the long-term. After analyzing his valuation models, the manager believes Stock Group is highly undervalued and that with growth in revenue and earnings over the next 3 years, the stock’s price will appreciate very quickly. He decides to purchase the stock today and hold for the 3 year term, unless some unanticipated events occur, and sell with a target gain of 300% (tripling the client’s money).
The Buy and Hold Strategy Advantages
One of the best reasons to go for a buy and hold investment strategy is that it works. Take Apple stock for example. If you bought 100 shares of its stock at its closing price of $17.70 per share in January 2008 and held on to it until July 2016, the price will have gone up to $95.37 per share. That’s a whopping gain of 442.20% in just 8 years. That means your initial investment of only $1,770 in 2008 would’ve grown to $9,597 simply by buying and holding Apple.
Another advantage of this strategy is that it’s easy. All you have to do is buy the stock and that’s it. It’s as passive as any passive investment can get. After you buy, you simply live your life and just wait for your investments to grow!
Another advantage of this strategy is that you’re spared from a lot of worry that comes with actively trading stocks. Trading anxiety is real, and it comes from stock prices’ short-term volatility. When you actively trade stocks, you have to really be on top of your portfolio’s price movements so you can optimize the timing of your trades. With a buy and hold strategy, you can enjoy peace of mind because investing long term allows you to ride out temporary storms in stock price movements when they happen.
The Buy and Hold Strategy Disadvantages
The primary disadvantage of a buy and hold investing strategy is that you have to commit your money to a stock for several years for it to work. While stock market investments are generally very liquid, the problem lies with the price at which you need to liquidate it should you need the money urgently. It’s common knowledge that stock prices don’t move in a flat line but in up and down movements that move in a general trend, usually upward over the long term. The risk of suffering significant losses lies in if you liquidate your investments at a point in time when its prices are significantly down. When you don’t sell immediately, losses incurred because of changes in market prices are just “paper” losses and not actual ones. But when you’re forced to sell when the price is down, the losses become real or actual.
Another disadvantage is obsolescence. Not every company is going to make it big or continue growing in the long run. Committing your money long term doesn’t entitle you to good returns. There’s still the risk of prices stagnating or even losing money on the investment.
Why Do Companies Become Obsolete?
If the company you choose fails to ride the wave of change over the next 3 to 5 years, it runs the risk of becoming dated. When that happens, income plateaus and eventually tanks, which will result in a drop in the price of its stocks over the long term. The key to managing this disadvantage is choosing the right company with a strong management and proven track record of being able to ride with changes that take place in its industry and the general economy.