Definition and Examples of the Buy-and-Hold Strategy
The buy-and hold-strategy is used when securities are held for long periods of time. If you buy and hold, it may be because you believe that long-term returns will be worth the short-term volatility that's common in stock investing. For example, you might buy shares in ABC Co. for $10 apiece. With a buy-and-hold strategy, you won't sell those shares, even if their value rises sharply next week, or falls dramatically the week after. Instead, you just leave your shares in your portfolio.
Buy-and-hold is in opposition to absolute market timing. With that method, you would attempt to buy stocks at low prices and sell them at high prices.
Buy-and-hold is a passive investing style. Put simply, those who buy and hold feel that "time in the market" is more important than "timing the market." It's not easy to time the market perfectly, but it's easy to hold on to a stock.
How Does the Buy-and-Hold Strategy Work?
The buy-and-hold strategy is very simple. You simply pick a stock or exchange-traded fund (ETF), buy it, and hold onto it for years, or even decades.
Buy-and-hold is most often a long-term strategy, but the exact length that you hold depends on why you're investing. For instance, if you buy and hold for your retirement fund, you may hold stocks for decades until you decide to retire.
Passive investing through buying and holding aligns with the Efficient Market Hypothesis (EMH). This theory states that all known information about investment securities (stocks, in this case) is already factored into the prices.
This theory runs counter to active investing, which requires using skill, knowledge, and research in an attempt to "beat the market." According to the EMH, an active investor cannot be any more effective than one who buys and holds.
Not all buy-and-hold investors believe in EMH. Buy-and-hold also aligns with value investing. Value investors often employ a fundamental analysis approach. They will attempt to find stocks in companies where the price is, in their opinion, low compared to the fundamental value of the companies.
Upon finding one of these stocks, they will buy it and hold it until something changes: Either the price of the stock will get so high that the stock is worth more than the company, or the company may change its business model in a way that lowers its value.
What It Means for Individual Investors
When you're deciding your investing strategy, you'll need to settle on your goals, your time frame, and your appetite for risk. Some investors are willing to take huge risks in hopes of a big payoff. Others may only have a short time frame in which to invest their money and earn returns.
Buy-and-hold is a strategy that may be better suited for investors with a lower appetite for risk and plenty of time in front of them. It also doesn't take much time or skill, unlike other types of investing. You just need to choose the right securities, buy them, and not sell them.
Consider whether a passive, long-term technique such as buy-and-hold could make sense for your goals.
Pros and Cons of the Buy-and-Hold Strategy
Lack of flexibility
- Cost savings: One key argument for buy-and-hold is that holding for longer periods requires less frequent trading than other strategies. That means trading costs are minimized, which can increase the overall net return of the portfolio. Even if your brokerage doesn't charge trade commissions, you can still benefit from more favorable capital gains tax rates.
- Risk reduction: The passive investing approach reduces what is called "manager risk." This is the risk that someone takes by actively managing their portfolio. In other words, by having a more passive strategy, you reduce the risk of human error.
- Simplicity: Buy-and-hold is simple, and it blends well with other simple strategies such as dollar-cost averaging and index fund investing. If you build a portfolio on these strategies, you don't need to make many choices or do much research. This largely automated approach saves time and makes investing easier.
- Price risk: Stock prices do rise and fall; there's never any guarantee about when a price will return to a certain level. If you buy and hold, you might not think about price as much as other types of investors. That could leave you more vulnerable to buying stocks when they're costly, and selling them when they're cheap.
- Principal risk: Principal risk applies to most types of investment, especially when it comes to stocks. It means there's no guarantee that your money will be there when you need it. The stock price could tank after you invest in a company, without ever recovering. If that happens, then you lose at least some of your initial investment, which is also known as your "principal."
- Lack of flexibility: A perfect buy-and-hold strategy always buys and holds, no matter the fluctuation of the market. In some cases, that can result in losses. One example was the Great Recession and the accompanying bear market. During that volatile time for stocks, active traders made much more money than those who bought and held.
- The buy-and-hold strategy is a form of passive investing in which someone buys securities and intends to hold them for years—even decades.
- The central idea of this strategy is that it's better to ride out any turbulence than to attempt to time the market.
- The buy-and-hold strategy may be used in conjunction with other strategies, such as dollar-cost averaging.