Buy and Hold Trading Strategy – Pluses and Minuses

Overview

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.

Negatives

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. Another drawback 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.

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One more major point against this strategy is that you can never be sure of the stocks you have picked especially in current market when a lot of blue chip and reputed companies are going bankrupt overnight.

Benefits

Buy and hold strategies have the following benefits:
  1. 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.
  2. Easy To Understand and Implement. Buy and hold is an easy investment system to employ. You identify strong assets with long-term growth potential, acquire them, and hold them throughout your investment horizon. No need to constantly monitor and trade as the short-term trends and volatility dictate.
  3. Consistent with Investment Theory. Conventional investment theory supports buy and hold investing. Over the long run, higher risk assets will outperform lower risk assets, on average. And historical data shows this to be true. Of course, at times one requires a very long time frame to see this out. It took 25 years for the Dow Jones Industrial Average to recover from its highs of 1929 and subsequent crashes. Had you been 30 or 40 years old and invested the bulk of your assets in the late 1920s, a buy and hold strategy would not have brought you success. So while it works in the long run, realize that long may not be 5 or even 10 years.
  4. Taxes. Since buy and hold strategies often call for a time horizon greater than 1 year, traders are taxed at a lower tax bracket.
  5. 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.

Risk versus Reward

The risks associated with using the buy and hold investment strategy varies based on two factors. First being the timing of your initial purchase. If you bought stock near the end of a bull market you will have to either sell at a loss or wait until the stock comes back from the bear market. Second factor relates to the length of your holding period. If you re-balance your portfolio selling poor performing stocks and you are in a bear market.

The rewards of using a buy and hold investment strategy varies greatly based on what stocks you have selected and what timeframes you are holding. What is apparent based off the number of investors who use this investment strategy is that is does have its strengths and can be used effectively to produce good returns.

Supporters

Warren Buffett, considered by many to be the greatest investor of all time, has said that he pays no attention to the stock market, and in fact, would not mind if the market shut down for a few years. He buys stock in a company as if he was buying the entire company. It's the value of the company that interests him, not the value assigned to it by the market. He wants companies that generate consistently growing profits.

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Or consider the remarkable case of Anne Scheiber. She represents, not only the superb returns that can be enjoyed from a skillful buy and hold strategy, but also the pluck to jump back in the game after losing everything.

In 1933 and 1934, at the height of the depression, 38 year old Anne invested most of her life savings in the stock market. She let her broker brother make the picks and they were good ones. Unfortunately, his company went bankrupt and she lost everything. But Anne did not give up.

On her modest salary as an auditor for the Internal Revenue Service (just over $3000 a year), she managed to save another $5000 over the next ten years. In 1944 she invested in the stock market again. When she died in January 1995 at the age of 101, that modest investment had grown to $20 million. That's not a misprint. $20 million! That represents an annual compounded rate of return of 17.5%, ranking her among the top investors of all time.

Her secret? Miss Scheiber invested in stocks of companies that she knew and understood. Companies whose products she used. She loved the movies. So she invested in Loew's, Columbia, Paramount and Capital Cities Broadcasting. She drank Coke and Pepsi and bought shares in both.

She invested in the companies that made medications she took - Schering Plough and Bristol Myers Squibb. And so on. And she hung on to them through thick and thin for over forty years. Through the bear market of 1973-1974… Through the crash of 1987…

Miss Scheiber left virtually the entire fortune to New York's Yeshiva University. By the time the estate was settled in December of 1995, it had grown to $22 million.



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