What Is Buy and Hold?
Definition, Strategy, and Criticisms of Buy and Hold Investing
In a day and age of fast news cycles and stock market volatility, is the buy and hold strategy still a good idea? What happens if the stock market crashes, like during the COVID-19 economic crisis? Is it best to hold on to your investments or should you sell, based on short-term volatility? Find out if buy and hold investing is right for you and your investment goals.
What Is Buy and Hold Investing?
Buy and hold is an investment strategy that is applied by buying investment securities and holding them for long periods of time. A buy and hold investor believes that long-term returns can be reasonable despite the volatility characteristic of short-term periods.
The buy and hold investing 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.
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 is a passive investing style.
How to Apply the Buy and Hold Strategy
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, an active investing strategy, where the investor attempts to use skill and knowledge to "beat the market" can be no more effective than a passive, buy and hold strategy.
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."
Benefits of Buy and Hold Investing
There are multiple benefits of a passive, buy and hold investment strategy, including cost savings, risk reduction, and simplicity:
Cost savings: A key 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 can increase the overall net return of the investment portfolio.
Risk reduction: The passive investing approach reduces what is called manager risk, which is the risk that an active manager will make mistakes, thereby producing lower returns than a benchmark index, such as the S&P 500.
Simplicity: 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. This simple, automated approach saves time and makes investing easier.
Risks and Criticisms of Buy and Hold Investing
The primary risks of the buy and hold strategy is similar to investing in general. These risks include the main types of market risk, which are price risk (volatility) and principal risk. The primary criticism of buy and hold centers around the lack of flexibility, which arguably increases market risk:
Price risk: Also associated with volatility (fluctuations up and down in price) price risk is the risk of falling market prices of an asset, such as stocks.
Principal risk: This type of market risk is the potential an investor can lose principal, which is the amount invested.
Lack of flexibility: The primary argument against the idea of buy and hold investing is that investors continue to hold investments regardless of market fluctuations. A historic 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 Jan. 1, 2000 through Dec.31, 2009 would have resulted in nearly a 0.00% return to the investor.
Critics of buy-and-hold may 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, through diversification, 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.
The Bottom Line
Buy-and-hold investing can be smart strategy for long-term investors who want to build wealth over time in a simple, low-cost way. Also associated with the passive investing strategy, the buy-and-hold strategy can achieve superior returns over long periods of time because of the cost savings.
PewTrusts.org. "Lost Decade Casts a Post-Recession Shadow on State Finances." Accessed March 26, 2020.