Buy and Hold Investment Strategy: Explained
By: Rupesh Oli
Introduction
Buy and Hold is an investment strategy whereby investors buy and hold financial assets (stocks or ETFs) or non-financial assets (real estate), regardless of market volatility in order to gain exceptional returns over the long haul. Buy and hold often refers to as passive management of the portfolio, wherein the investor gets rid of the hectic procedure to efficiently time the market, and chaos created by the market through the continuous ups and dips of the prices. Investors have minimal concern when it comes to technical analysis and stock price movements in the short run. All they do is, buy stocks of a company and not sell them.
However, buy and hold investment strategy demands a strong fundamental analysis skill from an investor so s/he could be able to choose a company with strong financials and have the capability to deliver consistent results over a period of time. Let’s take the example of Nabil bank in the case of Nepal. It is considered as the blue-chip stock denoting minimal risk, able to deliver consistent results over a period of time. The dividends it offers to its investors, majorly the bonus shares possess the huge potential to create a multiplier effect to your portfolio and leverage you exponentially.
The preference of investors varies when it comes to the selection of stocks. Some prefer value stocks that are currently trading under the market value also referred to as undervalued stocks. If done so, investors are not overpaying for the stock they want to own. On the other hand, some prefer growth stocks, performing exceptionally in recent years in terms of the return they are providing. They are considered to be worth the investment despite their higher P/E ratio due to the sharp future prospect they possess. Regardless of price fluctuations that a particular stock shows in the market, be it growth or value stock, an investor needs to hold a stock for a longer period of time, if they really want to be benefitted from a buy-and-hold investment strategy.
The greatest investors of all time have adopted the buy and hold strategy due to which they were able to garner exceptional returns during their dominant era in the market.
Example Illustrating Buy and Hold Investment Strategy
Source: Trading View
Let me depict the power of buy and hold strategy based on the stock price of Amazon. Suppose you allocated all your hard-earned money, managed to save $60,000, and then decided to invest it in the stock market. Through your $60,000, you managed to buy about 85 stocks on 03 January 2007 at the prevailing market price of around $700.
Capital you allocated through your savings = $60,000
Current market price on 03 Jan 2007 = $700 approx.
Stocks you managed to buy = 60,000/700 = 85 stocks
Since you are adopting a buy-and-hold strategy, let us ignore the price fluctuations in between. Let us get back to the year 2021 and see the price of a stock you bought, which is depicted below.
Source: TradingView
As of 01 December 2021, within the time span of 14 years, the stock price has risen from $700 to $3465. Let us calculate the return you gained through capital appreciation. One more thing to note down is, Amazon does not pay dividends to its shareholders as it is a growth stock.
Capital you invested = $60,000
Stocks you managed to buy = 85
Per stock price, you paid = $700 approx.
Per stock price as of 01 Dec 2021 = $3465
Your portfolio value as of 01 Dec 2021 = 85* $3465 = $294525
Return of Investment = (294525 – 60000) / (60000) * 100%
= 391%
You managed to gain an exceptional return of 391% within the time span of 14 years through Amazon.
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Pros of Buy and Hold Investment Strategy
As every investment strategy has both advantages and disadvantages, this section will emphasize the advantages buy and hold investment strategy possesses, and the disadvantages will be mentioned in the latter section.
1. You could save out on the recurring transaction fees on the buy and hold strategy, which would have been spent a lot when someone adopts a trading strategy instead. As the number of transactions would be very minimal or even zero in the majority of cases in the long haul like 10, 15, or 20 years, you would be saving on brokerage and advisory fees.
2. It is less of a hectic strategy when compared to trading because once you purchase the stock, you do not need to monitor the stock prices on a time-to-time basis and short-term volatility does not matter to you.
3. The rate of taxation on the long-term capital gain would be lower if compared to short-term capital gain, which benefits the investors as you will be giving up the small amount of capital you gained in your taxation charges.
4. It helps protect the investors from the emotional decisions they tend to take due to fear or greed during the market fluctuations. As investors start selling when the market is depicting a bearish signal and start to buy in hefty quantities when the market signals the bullish trend. Such hassle of trying to enter and exit the market is completely eradicated in the buy and hold strategy.
5. When an investor already knows they wouldn’t be selling the stocks they bought, for years or even decades to come, they do not have to worry about timing the market, and the emotions over the rational thinking would not prevail on them.
6. Buy and hold is a very simple and easy-to-follow investment strategy like index fund investing and dollar-cost averaging. Those who are feeble in technical analysis or lack time to do enough research, can go with this strategy and still make a huge chunk of profit over the period.
7. There is very minimal risk of human error in this passive approach of investing. As you would not be trading constantly, there are very few chances to misplace the order. For instance, it is obvious that you would be placing the order very constantly while trading. Suppose, you wanted to place the order for 200 stocks at $12 per stock. But what if you mistakenly place the order for $120? With an extra zero i.e. the human error, you would be paying much more than you really wanted to pay for. Hence, you would be safe on buy and hold strategy as you would not be constantly buying and selling the stocks, instead you would be holding the stock.
Cons of Buy and Hold Investment Strategy
1. Investors miss out on the opportunity to profit out from the market volatility. A dip in the market could have provided the opportunity for an investor to buy more stocks as they are available to them at the lower price point. As investors would already invest a hefty amount at once, they could be lacking the capital to invest on short-term fluctuations.
2. As you ignore the aspect of perfectly timing the market during your entry, you could be buying the stocks when they are costly. This leads you to purchase when the stocks are overvalued often, leading you in reduction of profit margin that would have been otherwise high if you could have bought the stocks when they were available at a discounted price, for instance, when the stocks dip down for correction.
3. As you would invest all your hard-earned capital at once and hold them, there is no guarantee that you would recover all the money when you require it. Let’s suppose that you require a certain amount in an emergency. What if you bought the stocks at $450 per stock and currently the stock is trading at $350? Here, you have to sell your stocks bearing the loss and it refers to as principal risk as you would be losing on the principal amount you invested. Hence, it is advised you invest only after allocating some emergency funds in your savings account.
4. You have to be aware of unprecedented events like market crashes or recessions that would not be coming knocking on your doors and make you possibly aware. Such economic turmoil could lead an investor to great trouble that they never thought of, or had not had the experience before. On one hand, you have the immense potential to reward yourself. However, you need to be ready for the possible negative outcomes that you would have to face, on the other hand. If you would have invested in a company like Enron, then you know the rest, how it collapsed after its illegal accounting practices were discovered.
5. It takes time to see the growth in buy and hold investment strategy. It’s not like you invest today and start seeing an out-of-the-world return in the next 5 or 6 months. It takes time and this is where your patience is required exactly. To see the power of compounding, maybe a time frame of 10,15, or even higher years is required.
When You Should Consider Selling Your Stocks?
When an investor adopts the buy and hold strategy, s/he should always be aware of the possible negative consequences that could arrive in the future. Your investment could not go as planned, sometimes. When your strategy signals are such, you need to have a backup plan or deviate from the previous plan you intended for. Major circumstances where you should consider selling the stocks you hold are when the company is on the brink of bankruptcy and an indication of accounting problems or fraud by the company. These are the two of the prominent cases where you need to abandon the hold strategy you previously adopted.
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When Should You Not opt For a Buy and Hold Strategy?
Buy and Hold Strategy may not be the best investment strategy depending on your investment skills and risk tolerance capacity. If you spend the majority of your time analyzing stocks and the overall market and are proficient in analyzing the technical aspects of the company which help you to execute your trading decisions, then a buy and hold strategy might not be suitable for you. Instead, you could opt for the trading whether it be intra-day trading, swing trading, or position trading, rather than walking down the paths of buy and hold investment strategy. Further, if you fall under the category, where you possess high-risk tolerance capability, then again better to go for trading strategy. If you feel fulfilled making real-time trades and enjoy trading the particular stocks through perfect entry and exit, then buy and hold investment strategy is not for you, again. To simply sum it up, if you are more inclined towards trading and possess strong technical analysis skills and study the market continuously based on its volatility, then you should go for a trading strategy instead of a buy-and-hold investment strategy.
Power of Compounding
The power of compounding is something that merely an investor who adopts a buy-and-hold investment strategy can be benefitted from. Albert Einstein once stated compound interest as the 8th wonder of the world. Further, he added, those who understand it, earn it; those who don’t, pay for it. Hence, it is something that every one of us, who are keen to know more about the financial world needs to be aware of.
The power of compounding is depicted with the help of two scenarios mentioned below.
You might be confused regarding how compounding actually works on stocks. It is actually trickier than the index fund, on which you will be getting an annualized return of 10-11% of compounded interest per annum, on average. However, on stocks, you would not be receiving a direct interest amount, instead, it is the actual value of the stocks that get compounded. Suppose, in the scenario I mentioned below, you invested $60,000 in the first year, and presuming you got the return of 10% on the very first year, your holdings will be worth $66,000 in the second year. The same goes for scenario II, as the worth of the actual amount you invested gets compounded. The example of both scenarios I &II can be applied to whatever you prefer might be a mutual fund or index fund also.
You might also be in a dilemma of why to take the high risk on stocks when the bank itself is able to provide around 9-10% on Fixed Deposit. It is only the case in Nepal where you would be getting a higher interest rate of FD because the inflation is also high if compared to foreign countries like the US, Germany, and other developed countries. In developed countries, inflation is controlled and is very low. The interest amount you would be receiving in FD is less than half, around 3-4% if compared to Nepal. Hence, through investment in stocks, mutual funds, index funds, you would be getting a return of more than double the amount.
Scenario I
Suppose you managed to perform an investment worth $60,000 and managed to gain stocks worth that amount and hold it for the next 30 years.
Note: The investment in stocks could be anything ranging from the variation of stocks in your portfolio, Exchange Traded Funds, or Index Funds.
And let us suppose the estimated interest of 10%, which is the average annual return of S&P 500, and it is practical enough to expect such a return.
Since, you did not care about the volatility in between, you hold the stocks for the long haul.
In the next 30 years, you would have turned your capital investment of $60,000 to $1,046,964.14 (a million dollars).
| Years | Future Value (10.00%) | Total Contributions |
| Year 0 | $60,000.00 | $60,000.00 |
| Year 1 | $66,000.00 | $60,000.00 |
| Year 2 | $72,600.00 | $60,000.00 |
| Year 3 | $79,860.00 | $60,000.00 |
| Year 4 | $87,846.00 | $60,000.00 |
| Year 5 | $96,630.60 | $60,000.00 |
| Year 6 | $106,293.66 | $60,000.00 |
| Year 7 | $116,923.03 | $60,000.00 |
| Year 8 | $128,615.33 | $60,000.00 |
| Year 9 | $141,476.86 | $60,000.00 |
| Year 10 | $155,624.55 | $60,000.00 |
| Year 11 | $171,187.00 | $60,000.00 |
| Year 12 | $188,305.70 | $60,000.00 |
| Year 13 | $207,136.27 | $60,000.00 |
| Year 14 | $227,849.90 | $60,000.00 |
| Year 15 | $250,634.89 | $60,000.00 |
| Year 16 | $275,698.38 | $60,000.00 |
| Year 17 | $303,268.22 | $60,000.00 |
| Year 18 | $333,595.04 | $60,000.00 |
| Year 19 | $366,954.54 | $60,000.00 |
| Year 20 | $403,650.00 | $60,000.00 |
| Year 21 | $444,015.00 | $60,000.00 |
| Year 22 | $488,416.50 | $60,000.00 |
| Year 23 | $537,258.15 | $60,000.00 |
| Year 24 | $590,983.96 | $60,000.00 |
| Year 25 | $650,082.36 | $60,000.00 |
| Year 26 | $715,090.59 | $60,000.00 |
| Year 27 | $786,599.65 | $60,000.00 |
| Year 28 | $865,259.62 | $60,000.00 |
| Year 29 | $951,785.58 | $60,000.00 |
| Year 30 | $1,046,964.14 | $60,000.00 |
Scenario II
Suppose you do not have a hefty amount to invest at once, so you decided to contribute 700$ worth of investment on a monthly basis for the next 30 years.
Again, let us suppose the estimated interest of 10%, which is the average annual return of S&P 500, and it is practical enough to expect such return.
Since you did not care about the volatility in between, you just bought the stocks on a monthly basis and let them be on hold for years to come.
In the next 30 years, you would have turned your capital investment of $700 monthly investments to $1,381,749.79 (more than a million dollars).
| Years | Future Value (10.00%) | Total Contributions |
| Year 0 | $0.00 | $0.00 |
| Year 1 | $8,400.00 | $8,400.00 |
| Year 2 | $17,640.00 | $16,800.00 |
| Year 3 | $27,804.00 | $25,200.00 |
| Year 4 | $38,984.40 | $33,600.00 |
| Year 5 | $51,282.84 | $42,000.00 |
| Year 6 | $64,811.12 | $50,400.00 |
| Year 7 | $79,692.24 | $58,800.00 |
| Year 8 | $96,061.46 | $67,200.00 |
| Year 9 | $114,067.61 | $75,600.00 |
| Year 10 | $133,874.37 | $84,000.00 |
| Year 11 | $155,661.80 | $92,400.00 |
| Year 12 | $179,627.98 | $100,800.00 |
| Year 13 | $205,990.78 | $109,200.00 |
| Year 14 | $234,989.86 | $117,600.00 |
| Year 15 | $266,888.85 | $126,000.00 |
| Year 16 | $301,977.73 | $134,400.00 |
| Year 17 | $340,575.50 | $142,800.00 |
| Year 18 | $383,033.05 | $151,200.00 |
| Year 19 | $429,736.36 | $159,600.00 |
| Year 20 | $481,110.00 | $168,000.00 |
| Year 21 | $537,621.00 | $176,400.00 |
| Year 22 | $599,783.09 | $184,800.00 |
| Year 23 | $668,161.40 | $193,200.00 |
| Year 24 | $743,377.54 | $201,600.00 |
| Year 25 | $826,115.30 | $210,000.00 |
| Year 26 | $917,126.83 | $218,400.00 |
| Year 27 | $1,017,239.51 | $226,800.00 |
| Year 28 | $1,127,363.46 | $235,200.00 |
| Year 29 | $1,248,499.81 | $243,600.00 |
| Year 30 | $1,381,749.79 | $252,000.00 |
Conclusion
Buy and hold is one of the best investment strategies, even recommended by the greatest investors of all time we have ever witnessed. Through trading, you would be accumulating profit in the short run, and could even bag the larger profit margin in between. However, if you want to achieve something massive and can see a bigger picture, then buy and hold investment is the way to go. If you are thinking of retiring without worrying about financial freedom, you would not be able to amass a huge sum of chunks through trading, you need to have the persistence and perseverance to go for a buy-and-hold investment strategy. For a second, think about the two scenarios mentioned above. Would you be earning a million dollars through your trading? Definitely not, right. Hence, buy and hold investment is the way to go, no matter how long it takes enormous time to see the real magic through the power of compounding. Nevertheless, you would be hoarding gigantic capital that you probably have never imagined of.
From The Author:
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