Warren Buffet was born during the depths of the Great Depression and bought his first stock at 11 years old. He’s come a long way since then and his net worth is now about $75 billion.
One of the secrets to his success: The buy and hold strategy in which investors hang on to their investments in hopes of long-term growth. Here’s a closer look at what the strategy entails.
What Is Buy and Hold?
A buy and hold strategy is a type of passive investment strategy in which investors buy equities and other securities—such as mutual funds, index funds, and exchange-traded funds (ETFs)—and hold on to them for a long period of time.
Investors believe that they are likely to earn long-term investment returns despite whatever short-term market volatility may come their way. They believe that a long time frame gives them the ability to ride out short-term dips in the market.
There is evidence to support this view. According to one Morningstar report from 2018, the stock market has increased over any given 15-year rolling period. The stock market is ultimately unpredictable, but this pattern suggests that investors who hold their stocks for at least 15 years will come out ahead.
Active vs. Passive Management
An active investment strategy is one in which money managers evaluate investments on a daily basis, potentially buying and selling stocks in the short-term as they attempt to find value.
While it may be possible that some money managers are able to outperform the market, critics say it is more likely they will be unable to beat it.
For example, consider economist Burton Malkiel’s famous claim in his 1973 book A Random Walk Down Wall Street that blindfolded monkeys throwing darts at a list of stocks would outperform many money managers. His claim garnered a lot of criticism at the time, but it’s perhaps no coincidence that the first Vanguard index funds appeared a few years later.
Passive investment strategies, on the other hand, typically seek to mirror an existing index, such as the S&P 500 or the Russell 2000. Portfolios are typically created through buying the stocks (or most of them) that already exist in the index.
That way, as the index rises and falls, so too does the portfolio. And the idea is if investors hold on to the portfolio long enough, it may gain in value.
Benefits of Buy and Hold
There are a number of benefits to practicing a buy and hold strategy from its simplicity, to tax savings, to avoiding emotional investing.
As a result of its passive nature, the buy and hold strategy can mesh well with investments such as low cost index funds that track an index and provide investors with a diverse basket of investments to help them build their portfolios.
When investors sell a stock they owe taxes—known as capital gains taxes—on whatever gains that stock has made in value. The amount they pay depends in part of how long the investor held the stock.
Stocks held for a year or less before they are sold are subject to the short-term capital gains tax rate, which is equal to the investor’s income tax rate. Stocks held longer than that are subject to the preferential long-term capital gains rate, Investments held with a buy and hold strategy typically fall into this latter category,
Other cost savings:
A buy and hold strategy might save investors money in other ways. Investors may incur fees when they buy and sell stocks and other securities. If the investor pursues an active trading strategy with frequent buying and selling, these fees can add up quickly. Infrequent trading in a buy and hold strategy minimizes these costs.
Helps protect against emotional investing:
Emotional investing is the tendency for investors to make decisions based on emotions like fear or greed. For example, when markets are down, investors may panic and pull their money out of the market. Doing so can lock in losses and mean missing out on subsequent market rebounds. Conversely, an investor might see a particular stock doing really well and buy it when it is potentially overvalued.
This tendency to follow emotions over rational thinking can lead investors down a path that ultimately derails their investment plans. A buy and hold strategy can help combat this tendency.
If an investor knows they won’t be selling a stock for years or even decades to come, they don’t have to worry about making decisions to buy and sell in the short-term, even when market conditions get tough.
Helps avoid timing the market:
Figuring out the best time to jump in and out of the market is hard, even for the most seasoned professionals. It typically requires a lot of research and even the experts often don’t get it right. By nature, a buy and hold strategy avoids timing the market. It also aligns neatly with another anti-market-timing strategy known as dollar-cost averaging.
Investors who practice dollar-cost averaging buy a fixed dollar amount of stocks or other securities on a regular basis no matter the share price. When prices are up, aka when stocks are expensive, the investor buys fewer shares.
When prices are down and stocks are cheaper, the investor is able to buy more shares. Because dollar-cost averaging places the focus on a regular amount of money rather than share price, there is less temptation to time the market. At the same time, the investor is able to continue to build their long-term portfolio.
Drawbacks of Buy and Hold
There are also some risks and drawbacks to a buy and hold strategy.
It ties up capital:
A buy and hold strategy is relatively inflexible. Investors park their money in the market and then they don’t touch it for years.
As a result, there may be some opportunity cost involved, as money that’s tied up in the market theoretically can’t be used for anything else. This is ultimately the point of buy and hold strategies, but investors must be careful not to be tempted to pull their money out of the market and use it for other reasons.
A buy and hold strategy does not make investors immune to market risk, the risk that they will experience losses as a result of movements in the market at large. It is possible that markets could crash just as an investor is ready to take their money out of long-term investments—if they’re ready to retire, for example.
A diversified and properly balanced portfolio may help investors avoid taking on too much market risk.
A stock or fund that consistently underperforms can end up in a portfolio. And if investors aren’t careful, the buy and hold strategy may mean that investment sticks around for a long time.
That’s why it’s important for investors to get a good look under the hood before they buy individual stocks or funds. Understanding exactly how a company is run or how a fund is managed can help investors decide whether it is a good fit for them.
Additionally, regular check-ins can help investors keep tabs on investments. If after a lengthy period of time an investment seems to be a poor fit, investors may want to consider swapping it out for something that is more in line with their investment plan and goals.
Who Is Buy and Hold Good For?
Successful financial plans are built with an investor’s goals, time horizon, and risk tolerance in mind. A buy and hold strategy works best for investors that have long time horizons.
This may mean they have large long-term goals like saving for their kid’s education or their own retirement.
The long time horizon gives investors the chance to ride out short-term market volatility while capitalizing on whatever long-term gains their portfolio makes.
Near-term goals and short time horizons may not be suited to a buy and hold strategy.
For example, if an investor is saving to buy a new car in the next three years, buy and hold may not make sense. Rather, that investor may consider putting their money in a savings vehicle that avoids market risk, such as a high-yield savings account.
Remembering to Rebalance
In many ways, a buy and hold strategy is a way to set it and forget it. It’s that type of thinking that can help investors avoid panic selling stocks when markets are volatile.
At the same time, portfolios are dynamic, and it’s a good idea to check up on them on a regular basis—once a year or quarterly—to determine if they need to be rebalanced.
If the stock market is doing well, for example, a portfolio may become overallocated to stocks. At that point an investor may choose to sell some stocks and purchase bonds, or simply pull back on buying new stocks in favor of new bond purchases.
Regular rebalancing helps ensure that a portfolio stays on track toward meeting investment goals.
With SoFi Invest®, you can buy and hold with the automated investing option. “Setting it and forgetting it” is a good way to manage this strategy. Or, if you’re more into active investing, SoFi has a hands-on option as well.
Additionally, with SoFi you have access to financial planners, who may be able to help you to determine an investing plan that suits your goals and needs. And with the SoFi app, you can stay up to date with current market news and trends.
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