A buy and hold strategy in investing is a specific passive investment strategy that involves an investor buying financial instruments and securities or non-financial assets such as real estate and holding them for possible medium-term to long-term profits or investment returns regardless of market fluctuations or short-term price movements.
It is sometimes referred to as a long-term passive investment strategy. The major goal of this buy-and-hold approach in investing is to maintain a stable or unchanged portfolio of assets for 10 years or more with an expectation for capital appreciation.
Hence, investors who follow this approach are confident that the value of their investments will be higher in the future. For this reason, it is also imperative for would-be investors or those who want to adopt this strategy not to be affected by recency bias caused by current events and must have control over their emotions.
Real-World Examples of Buy and Hold Results
Understanding the benefits of a buy-and-hold approach to investing simply requires referencing the historical data of some notable assets. Consider Apple stock as an example. The price of its stock was around USD 0.90 to USD 2.00 in 2005. By the end of 2020, its stocks traded at around USD 121.00 per share. This is about 5950 percent growth.
Another example is the cryptocurrency Bitcoin. A single Bitcoin was priced at USD 340 at the beginning of April 2014 and this has substantially gone up to USD 60000 in April 2021. This is a 17547.1 percent growth in just seven years.
There were fluctuations in the respective prices of Apple stock and Bitcoin. However, buying and holding these assets for a longer period would be a better strategy than selling them. Historical data have shown that the prices of these assets have grown in an upward trajectory in general despite some instances of significant lows and highs.
The Pros: Advantages of Buy and Hold Investment Strategy
Prominent investors such as Warren Buffett, one of the wealthiest people in the world and the chief executive of Berkshire Hathaway, and Jack Bogle, founder and chief executive of The Vanguard Group and credited as the creator of the first index fund, noted that a buy-and-hold approach is ideal for individuals seeking health long-term investment returns.
Nevertheless, buying and holding assets can be beneficial to certain individuals and institutions. The following are the details of each advantage:
1. Easy to Implement
For starters, one of the advantages of a buy and hold strategy is that it is easy to implement. Unlike trading strategies such as day trading and swing trading, which both involve buy-and-sell strategies that are done in consideration of market timing and in a shorter span of time, buying and holding assets center on an invest-and-forget attitude.
Remember that this strategy is a form of passive investing. Investors do not need to actively buy and sell their assets, reference most recent historical price data to perform regular fundamental and technical analyses, and respond to current events and short-term market outlook to time the market. Doing any of these three require time, effort, and skills.
2. Availability of Options
There are also a number of investment options and vehicles available to investors. Of course, there are brokers that can help an individual or institution choose the most suitable financial instruments and non-financial assets based on specific risk appetite. Examples include stocks, bonds, money markets such as time deposits, and futures contracts.
Other examples include real estate, commodities, precious metals such as gold and silver, artworks, real estate investment trust or REIT, financial derivatives such as options, and cryptocurrencies such as crypto-coins and crypto-tokens, non-fungible tokens.
Then there are the so-called pooled funds, which are managed by professional fund managers. Examples of pooled funds include mutual funds, unit investment trusts or UITF, investment-linked insurance policies or variable unit-linked insurance, pension funds, exchange-traded funds, and pooled REITs and real estate stocks, among others.
3. Tax and Cost Savings
In several countries such as the United States, long-term capital gains and dividends from owning stocks are taxed lower than short-term capital gains. There are also jurisdictions with laws that warrant tax due only and when if the assets are sold. The tax rate can be as low as zero percent depending on the taxable income and filing status of an individual.
Furthermore, because this strategy is passive, there are considerable savings from lower commission and transaction fees. Note that each transaction incurs commission and transaction costs. Passive investing has fewer transactions than active investing, as well as trading.
It is also worth mentioning that pooled funds are a relatively affordable way to build a financial portfolio. Compared to purchasing assets such as stocks and cryptocurrencies, as well as to building a diverse portfolio by buying different types and classes of assets, an individual can have a readily available diverse portfolio with fewer pooled fund accounts.
4. Outperforms Active Management
Several studies and analyzes have shown that buying and holding assets can outperform active management of investments in certain instances. A 2019 review study by E. J. Eton, M. J. Gruber, and A. de Souza noted the existence of several papers that passively managed funds have outperformed actively managed ones based on historical data.
Furthermore, a 2019 empirical analysis of the German equity market by E. J. Fahling, E. Steurer, and S. Sauer showed that the costs or expenses attached to fund management offset the positive gains and value-creation potential of actively managed funds. It concluded that active funds do not create significant value in general.
5. Cost Averaging Advantages
Another advantage of a buy and hold strategy is that it can exploit the potential and benefits of cost-averaging. Note that cost averaging is another investment strategy that involves purchasing assets at predetermined intervals and set limits over a long period. Doing so means buying these assets across different price points or market conditions.
The goal of cost averaging is to lower the amount of money used to buy assets and minimize risks. Note that buying the same asset regularly over a long period means buying it across different price points. These price points can be higher or lower. However, over the course of time, the collective price represents the average of these different price points.
The Cons: Disadvantages of Buy and Hold Investment Strategy
1. Growth Takes Time
Note that there is a difference between investing and trading. Investing centers on seeking large returns over an extended period through buying and holding while trading maximizes the highs and lows in the market to make enter and exit positions over a shorter time frame to take smaller albeit more frequent profits.
Trading can be more attractive because it can provide the most immediate profits or investment gains. Successful traders can generate profits within weeks, days, and even minutes. Gains in investment can take at least 10 years or more. Nevertheless, one of the notable disadvantages of a buy and hold strategy is that it will take time to see actual growth.
2. Return-Chasing Tendency
Buying and holding assets require a strong resolve. There are instances in which investors would buy assets or pooled funds with high past returns and sell their existing low-performing assets or funds. This is called return-chasing behavior. However, this tendency can reduce profits because investors can miss out on the potential of a true buy-and-hold approach.
Economist YiLi Chien wrote that return-chasing behavior is common among mutual fund investors. There are a lot of investors who readily react to the latest price movements in the market. Her analysis showed that they miss around 2 percent of return per year. She noted that those who buy and hold can earn an average of 5.6 percent return each year.
3. A Note on Market Crashes
Investments have risks. All strategies and gains are not guaranteed. This is an inevitable truth. Although buying and holding assets for a longer period can provide more substantial gains than active investment and buy-and-sell trading, it is important to note that this strategy is not infallible to market crashes and economic downturns.
Holding an asset for too long can backfire. Consider owning Enron stocks for example. The discovery of its illegal practices caused its stock price to go down from USD 90.00 to USD 0.60. The company disbanded eventually. Investors who held Enron shares essentially suffered from significant and unrecoverable financial losses.
Understanding and Appreciating When to Buy and Hold
The key advantages of a buy and hold strategy in investing include evidence-supported potential for substantial gains or investment returns, support from tenured investors, considerably ease of implementation that is less time-consuming, and tax and other cost savings. However, this investment strategy is not for everyone.
It can be a poor strategy because of the associated risks involved. Market crashes can significantly affect the value of certain held assets, thus compelling investors to sell them at a loss. Investors need to have a strong resolve. However, resolve alone is not sufficient. There are instances in which an asset has failed to recover or completely lost its value.
The key to a successful buy-and-hold approach is diversification. Risks and opportunity costs can be managed or mitigated by creating and holding a diversified financial portfolio composed of different financial securities and instruments or assets.
FURTHER READINGS AND REFERENCES
- Elton, E. J., Gruber, M. J., and de Souza, A. 2019. “Are Passive Funds Really Superior Investments? An Investor Perspective.” Financial Analysts Journal. 75(3): 7-19. DOI: 1080/0015198x.2019.1618097
- Fahling, E. J., Steurer, E., and Sauer, S. 2019. “Active vs. Passive Funds—An Empirical Analysis of the German Equity Market.” Journal of Financial Risk Management. 08(02): 73-91. DOI: 4236/jfrm.2019.82006
- Weisenthal, J. 2014. “An Obvious Psychological Mistake Is Costing Investors A Fortune.” Business Insider. Available online
