What is Buy and Hold?
Definition, Strategy and Criticisms of Buy and Hold Investing
Is the buy and hold strategy still a good idea? Like weight loss fads, investment strategies come and go. Some are effective and others are not. But the basics are often the most effective. If you want to lose weight, diet and exercise are the best strategies. Similarly, buy and hold investing, when applied properly, is the best investment strategy for most investors.
If you want to learn how and why investors benefit from a buy and hold strategy, you are wise to begin with the basics and expand your knowledge from there. Most importantly, the universal virtues of simplicity and patience are the most valuable with investing in the long run.
Buy and Hold Definition
Buy and hold is an investment strategy that is applied by buying investment securities and holding them for long periods of time because the investor believes that long-term returns can be reasonable despite the volatility characteristic of short-term periods. This strategy is in opposition to absolute market timing, which typically has an investor buying and selling over shorter periods with the intention of buying at low prices and selling at high prices.
Furthermore, an argument for the buy-and-hold strategy is that an investor holding for longer periods requires less frequent trading than other strategies. Therefore trading costs are minimized, which will increase the overall net return of the investment portfolio.
Put simply, buy and hold investors believe that "time in the market" is a more prudent investment style than "timing the market."
Buy and Hold Strategies and Elements
Buy-and-hold investors employ the passive investing strategy that aligns with the Efficient Market Hypothesis (EMH), which essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities. Therefore no amount of analysis can give an investor an edge over other investors.
Typical buy-and-hold investors will also use other passive elements, such as dollar-cost averaging and index funds, while focusing more on building a portfolio than on security research and selection. To paraphrase famous value investor, Warren Buffett, "Don't buy anything you wouldn't be willing to hold for 5 years."
The buy-and-hold strategy has also been aligned with value investing, which will often employ a fundamental analysis approach where the investor will attempt to find stocks of companies with low relative valuations, implying the intention of holding the stock until it no longer appears to be "a value."
Criticisms of the Buy and Hold Investing
The sharpest criticism for buy-and-hold comes when the strategy appears to be non-productive or invalid. The most recent example followed the Great Recession and accompanying bear market when active traders declared the death of buy and hold. Many investors understandably began doubting buy and hold because of the so-called "lost decade" for stocks where the buy-and-hold strategy (holding an S&P 500 Index mutual fund) from January 1, 2000 through December 31, 2009, would have resulted in nearly a 0.00% return to the investor.
Most critics of buy-and-hold do not recognize the fact that the strategy is quite broad and often includes small elements of timing, such as dollar-cost averaging, which is passive but it does enable the buy-and-hold investor to buy shares at low prices, as well as higher prices. This practice would also have significantly improved returns for a buy and hold investor during the so-called "lost decade."
Furthermore, a buy and hold investor who also held bond funds in their portfolio the Great Recession and following bear market would have had positive returns during the lost decade. Why don't critics include tactical asset allocation and these portfolios in their arguments against buy and hold?
Buy and Hold and Passive Investing
The passive approach also minimizes common mistakes that market timers and technical traders can make, which is to underestimate the irrationality of the investor crowd. For example, a technical trader may sell stocks at a recent high (resistance level) but the investor sentiment may cause prices to break through that level, sending prices significantly higher. However, the buy-and-hold investor can capture this over-zealousness within their portfolio return.
To conclude, investors should be careful not to allow others to define or label their investment strategy, philosophy or tactics. Equal and opposite, it is important to remember that the greatest enemy of the investor is likely to be him or herself.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.