Buy and Hold Strategy - Negatives & Benefits
Buy and Hold is a basic investing strategy where investors buy and hold a security for an extended period of time. The belief is that it is better to allow a security the opportunity to grow over time, versus attempting to trade in and out of a stock for quick gains. Buy and hold traders see stocks as investments and are not concerned with timing each move. The logic behind the strategy is that the economy will grow overtime and by avoiding selling during normal cyclical downturns, a trader will ultimately be more successful over a multi-year timeframe. There have been a number of studies done which show that over the long run, stocks outperform any other investment (real estate, bonds, etc.). Until the advent of hedge funds, many large money managers believed that it was silly to move in and out of the market due to increase commissions and the risk associated with each new trade.
Selecting Stocks for a Buy and Hold Strategy
In order to get the most out of a buy and hold strategy, the odds are stacked in your favor when trading the strongest stocks. An investor should first start out by identifying the strongest performing index. The next step is to target the strongest stocks within that respective sector. This basic top down approach will ensure that the trader is purchasing into a stock with the greatest chance of growth potential.
The buy and hold strategy may give the appearance of a safer investment model, but it, like every other strategy is not above the element of risk. For example, traders that bought Microsoft 8 years ago, would have made less than 2% on that investment. The other buy and hold killer is bear markets. If a buy and hold trader purchases a stock prior to a swift market decline similar to the ones in ’87 and ’02, the trader may have to wait 5-10 years to breakeven on their initial investment. The last sour note for the buy and hold strategy is the fact you have to buy and hold. Making money in the market is not like working a job where more effort equals greater results. So, traders will have to fight the urge to overtrade, as the key to a successful buy and hold strategy is quality not quantity.
Buy and hold strategies have the following benefits:
- Less Stress – by trading fewer stocks and not concerning oneself with every price movement, it makes it easier for a trader to follow their trading plan and stay the course.
- Taxes – since buy and hold strategies often call for a time horizon greater than 1 year, traders are taxed at a lower tax bracket.
- Commissions – active trading can prove costly. Traders can easily rack up commissions in the tens of thousands each year, even with a discount broker. A Buy and Hold strategy can allow a trader to invest large sums of money with minimal costs. With many brokers offering $9.99 per trade for an unlimited number of shares, the buy and hold strategy has never looked more appealing.