If you’re just getting started in the stock market, you may hear people talk about holding stocks long-term. But what does this mean? They are likely referring to the buy-and-hold strategy, which is a passive investing strategy favored by most investors, myself included. The goal of buying and holding is to hold positions in securities for a long time and ignore any short-term fluctuations.
Before you take a position in a stock, you should take some time to learn more about the buy-and-hold strategy to assess whether it is a good fit for your investment goals. In this article, we will discuss what the-buy and-hold strategy is and its pros and cons.
- The buy and hold strategy is best for passive investors with a long time horizon. With this method, investors consistently invest in the market regardless of whether it is rising or falling.
- Some advantages of the buy and hold strategy include more favorable tax rates, less time and effort needed, consistent gains, and reduced risks. Some disadvantages include missing out on potential gains, needing to stay disciplined, and principal risk.
- If patience is not one of your strengths, consider active trading, which focuses on taking advantage of price action in short timeframes.
What is the Buy and Hold Strategy?
As the name implies, investors will select securities to buy and hold for the long term. Depending on your financial goals, that could mean years or decades. If you buy and hold, you believe that the value of your securities will grow over time with the market and become more valuable in the future. Any short-term fluctuations will have no impact on your positions because their value should steadily rise even if you do nothing.
The buy and hold strategy is best for passive investors who believe that “time in the market is better than timing the market.” With this method, you are consistently investing in the market regardless of what’s happening. Research shows that it is hard to predict what will happen in the stock market. Most people have absolutely no idea, myself included. If you anticipate a market crash and sit on the sidelines waiting, you could miss out on a massive bull run.
When the stock market crashed in March 2020 because of the pandemic, I made this mistake. Though I did buy some stocks I had been eyeing during the crash, I thought that the market would take a longer time to recover and held back from investing as much as I could. Because of my overconfidence in my prediction, which has since been proven wrong, I missed out on massive returns. While I was waiting on the sidelines, stocks on my watchlist, such as Square, Roku, Tesla, Nvidia, and Netflix, doubled, tripled, and even quadrupled in value. Since then, I now focus on finding good entry points in stocks I’m interested in and consistently dollar-cost average into positions, as well as buy the dips.
But, keep in mind that not all stocks are created equal. Before you place the buy order, you should conduct due diligence and use fundamental analysis to determine if the company is valuable. Ask yourself a few key questions, such as:
- Do you understand what the company does?
- What types of products or services does the company offer?
- How does the company’s historical performance look?
- What is the company’s long-term growth strategy?
- How does the company’s financials look? Are they profitable? Do they meet expected earnings every quarter? What is their debt-to-equity ratio?
- Do they have an effective management team?
By using fundamental analysis, you can better understand what you are investing in and find stocks that will grow in value over time. As a best practice, you should not invest in securities that you plan on holding if you do not understand them. If you hold stocks without knowing anything about them, that exposes you to a higher risk of losing your initial investment.
Advantages and Disadvantages
Like with any strategy, there are pros and cons to buying and holding. We’ll break down the key advantages and disadvantages you should take into consideration below.
When you sell a capital asset, such as stocks, bonds, or real estate, any profits you make will be considered capital gains. Therefore, they will be taxed. The tax rate depends on how long you’ve held the asset. Short-term capital gains are taxed at your regular income and apply to assets held for one year or less. Long-term gains are taxed at a much lower rate and apply to assets held for more than one year.
As you can see in the breakdown above of short-term versus long-term capital gains tax rates, holding stocks for more than one year leads to much more favorable tax rates. If you are a high-income earner, the short-term tax rates can eat up a lot of your profits.
Less Time and Effort Needed
Adopting buy and hold is simple and easy. You only need to do your research once and pick out your top companies to invest in. We recommend checking on your stocks every once in a while and making adjustments as needed. But, you do not need to look at your portfolio every single day. With this strategy, you minimize the number of trades you make, which saves time and effort.
It’s Hard to Beat the Market
Historically, the majority of people who actively trade will lose money. In a recent report by the S&P Dow Jones Indices, 88.99% of large-cap U.S. funds underperformed the S&P 500 index, which is a commonly used benchmark for performance, over ten years. Aside from the professionals, some 90-95% of day traders will fail because of the time, effort, and discipline required to be a day trader. With active trading, you need to iterate on your trading strategy and manage your risk. With the buy and hold strategy, you can leave your portfolio alone for months and not have to worry about it going to zero.
By taking a passive investment approach, you reduce your likelihood of human error. Active trading exposes you to risks that you would likely not have to face if you buy and hold. Because active trading requires making more decisions and trades, you have more chances to make mistakes. If you do solid research once before investing in a company and hold, you are more likely to make money over time.
Missing Out on Potential Gains
One of the biggest arguments against the buy-and-hold strategy is the opportunities that investors miss out on by not taking advantage of market volatility. With short-term trading, traders try to time the market and leverage volatility to lock in returns early on. Successful traders can profit in seconds or minutes by buying into a momentum stock and selling immediately. However, with long-term trading, investors generally ignore short-term fluctuations in the market and sit on unrealized gains.
Hard to Take the Emotions Out
The buy-and-hold strategy takes discipline and mental strength. For most people, “losses hurt more than gains feel good.” It is not easy to watch a stock in your portfolio drop 10 or 20% in value, even if you know it is only temporary. I felt the pain when my growth stocks lost 30, 40, or even 50% in gains over the last few months. With buy and hold, understanding market psychology and learning how to control your emotions will be crucial to being successful. If you have done all your homework on your investments, you need to make sure that you don’t let your emotions take over and cause you to make poor decisions.
With most investments, but especially stocks, there is no guarantee that you will make money. You could invest in a stock one day and watch your investment lose half of its value the next. No matter what your investing or trading strategy is, you should always consider the risk-to-reward ratio. The way I approach investing is that I only invest money that I’m willing to lose. Because I have an emergency fund set up already, I do not need to pull any of my investments out if something unexpected happens. While I like to believe that I make solid investing decisions, I do not know everything and often make mistakes.
Points to Consider
While the buy and hold strategy is a passive investing style, that doesn’t mean you should completely take your hands off after you make your initial investment. Because the stock market is constantly fluctuating, you should check the news every once in a while and consider any short-term fluctuations that can affect your stocks. Though most of my investments are long-term holds, I have many individual growth stocks in my portfolio, which are more volatile. For my peace of mind, I like to stay up-to-date on relevant economic, political, and financial news. If any negative changes affect my portfolio, I’ll adjust my strategy accordingly.
With this strategy, staying diversified will go a long way towards building wealth. By diversified, we mean investing in multiple assets and developing several streams of income. While I try my best to diversify my stock portfolio, I tend to favor technology and high-growth stocks. But, I also invest in cryptocurrencies and hold cash to ensure that I don’t lose all my money if something goes wrong. Since the pandemic, I’ve come to realize the importance of spreading my investments across different asset types and developing multiple streams of income.
Alternatives Active Trading
If you’re looking for more excitement, active trading may be a better fit for you. For some people, the buy and hold strategy is boring and leads to missed opportunities. With active trading, traders can take advantage of fluctuations in the prices of securities to make quick profits. Generally, these traders use technical analysis, rather than fundamental analysis, to identify trends and patterns in the financial market of their choice. Because traders can be in and out of a position in seconds, it makes more sense to set up a solid trading strategy than understand what the company does.
Most active traders fall under two camps: day trading and swing trading. Day traders typically make many trades in a day and will not hold securities overnight. Swing traders take advantage of swings in different securities and hold onto an asset for a few days or weeks. Given the amount of time it takes to be a successful day trader, most serious day traders trade full-time. Because swing trading takes place in a longer time frame, swing traders can hold a full-time job and trade simultaneously.
Though I consider myself a long-term investor, I make some swing trades or day trades once in a while. Since I am in a few Discord trading servers and actively check Reddit and Twitter to gauge market sentiment, I sometimes join in on a trend or momentum play. However, for those trades, I actively check the prices. Even if my capital in those stocks is relatively low as a percentage of my portfolio, it does feel more nerve-wracking (and entertaining) because of how volatile they are.
Is This The Right Strategy For You?
Before you adopt the buy and hold strategy, there are a few things to consider:
- Risk tolerance
- Financial goals
- Level of financial literacy
- Personal preferences
If you are a beginner, your best bet is to learn the basics first before making a significant investment in the stock market. If you are risk-averse and want to preserve your capital, then the buy-and-hold strategy will likely work best for you. The same goes if you don’t have a lot of time or capacity to do research. However, if you like taking risks and have a lot of time on your hands, buying and holding may not be the right approach for you. If you enjoy gambling and thrive with volatility, active trading may be more suitable for you.
Understanding your financial goals will help you determine how aggressive you want to approach investing. If you are investing for retirement, the buy-and-hold strategy will be perfect for you. If you have massive amounts of high-interest debt, then maybe prioritizing that over investing will be better for you. Figuring out what you want out of investing will guide your management style and provide clarity on how you should invest to reach your goals.
At its core, a buy-and-hold approach is a form of passive investing style meant for investors to hold onto securities for years or decades. It focuses on the belief that having money in the market over time will reap benefits. However, you do not need to silo yourself into one investing style. You can employ different investing styles in your strategy based on your needs and wants.