What is Buy and Hold Strategy?
The buy and hold strategy refer to investors’ investment strategy where they buy/invest in securities for a long time with no intention to sell in a short period. Instead, it refers to investment for a long period by retaining the investment, usually ignoring the ups and downs in market price in a short period.
Investors follow this buying strategy and rely on the company’s fundamental analysis in which they plan to invest. Fundamental analysis includes factors such as past performance of the company, its long-term growth strategy, types of products that the company offers along with their quality, working of the company’s management, etc.
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Buy and Hold Strategy Explained
The buy and hold strategy is the long-term investmentLong-Term InvestmentLong Term Investments are financial instruments such as stocks, bonds, cash, or real estate assets that a company intends to hold for more than 365 days in order to maximize profits and are reported on the asset side of the balance sheet under the heading non-current assets. strategy, which is ideal for investors who do not have the time to keep following up on their investment portfolio. Rather than treating the stocks or bonds as a short-term vehicle to make profits, investors in the buy-and-hold strategy keep the stocks through both the bull market and the bear markets.
It is easy to implement this strategy as there is a one-time selection of stock, and no requirement is there to monitor the stock prices and consider the short-term fluctuations in the market. However, in this strategy, it is required that investors should be able to handle the impact of the downturns and should not make wrong decisions in a panic.
While going for this strategy, fluctuations of short-term nature in the market, inflation, business cyclesBusiness CyclesThe business cycle refers to the alternating phases of economic growth and decline., etc., are avoided and not considered the deciding factor.
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Explanation of Buy and Hold Strategy in Video
Let us understand the concept of passive buy and hold strategy and its implications through the examples below.
Mr. X having $ 500,000 to invest in different areas and preparing the portfolio to earn the maximum return based on the different parameters suiting its requirements, such as risk, goals, and tax. Then, seeing the market conditions, he decides to invest 50 % of the money in stocks, i.e., $250,000, 20% in bonds, i.e., $ 100,000, and the remaining 30 % amounting to $ 150,000 in the risk-free government-issued-bills.
After the tenure of two years, it is observed that there comes a sharp rise in the value of the stocks in which the investment was made, increasing the weights of the stock in the portfolio from 50% to 75% and reducing the proportion of bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period. and risk-free assets to 10% and 15% respectively.
- Now, as per the prevailing situation, an investor has two options that he can follow. Firstly he can maintain the original ratio of the different class of assetsClass Of AssetsAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.. He has to sell some of his stocks to maintain the same ratio. In this case, he is not holding the stocks for a long period and thus not following the buy and hold strategy.
- On the other hand, an investor can refrain from portfolio rebalancingPortfolio RebalancingPortfolio Rebalancing is reallotment of the assets according to their performance in the past period and desired results. This is done by divesting in the low performing assets and investing more in the best performing ones. leaving the investments as it is, i.e., no stock will be sold to maintain the ratio. The portfolio will be kept intact. In this case, where the investor is not making any changes in the portfolio, he is holding the stocks for a long period and thus following the true strategy of buy and hold.
Mr. X believes in the strategy of buying and holding as he believes that the return in the long term will be more, and he doesn’t have the time to watch the short term fluctuations in the prices of the stock in the market.
In June 2013, he saved $2300 and invested in Facebook Stock. In June 2013, the closing prices of the stock of Facebook on the date he purchased the stock were $23 per share. So with the $ 2,300 amount, he bought 100 shares of Facebook at the price of $23 per share.
He had held the stock for 11 years and sold all the shares in July 2019, when the stock prices increased to $ 204 per share. It can be observed that the prices of the shares increased by $181 per share during the holding period of Mr. X, which makes nearly 786% return in just six years. It is the strategy of the buy and hold, which worked very well in the case of the purchase of stock of Facebook by Mr. X, thereby giving him excellent results.
- Even though one holds the securities for the long-term in case of a buy and hold strategy, they should still consider the fluctuation in price and any news relating to the market and that stock to avoid the situation of unlimited losses.
- This strategy does not apply only to stocks or bonds, but at the same time, they apply to the real estate sector as well, where the investors purchase houses without flipping them. In this case, generally, the investors will take a mortgage to gain the benefits of leverage.
- While investing in this strategy, a person must be investing in a well-diversified portfolio.
Advantages & Disadvantages
Let us understand the advantages and disadvantages of buy and hold strategy stocks through the discussion below.
- As the total number of transactions is lower in the case of a strategy of buy and hold, the brokerage, advisory fees, and sales commissionSales CommissionSales commission is a monetary reward awarded by companies to the sales reps who have managed to achieve their sales target. It is an incentive geared towards producing more sales and rewarding the performers while simultaneously recognizing their efforts. A sales commission agreement is signed to agree on the terms and conditions set for eligibility to earn a commission. are also low in this strategy.
- In this case, the stocks will be held for the long term and then only it will be sold. So here, a long-term capital gain will be applicable. The tax rate on long-term capital gain is lower than that of short-term capital gain, which is beneficial for the investors.
- It is easy for one to adopt this strategy, as in this strategy, only a one-time selection of stock is required. Also, after purchasing the stock, one is not required to monitor the stock prices and consider the short-term fluctuations in the market.
- In the case of this strategy, it is required that investors should be able to suppress behavioral biases and handle the impact of the downturns emotionally. Thus, the investors’ risk toleranceInvestors' Risk ToleranceRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition. should be high as the buy and hold is easy to implement but difficult to follow correctly.
- In this case, the stocks will be held for the long term regardless of fluctuations in the price or the news regarding the company; no limit is there for the possible losses if any negative event occurs concerning the market or stock. If there comes any negative news concerning stock purchased by the investors, the company becomes bankrupt. In that case, investors would also continue holding that stock until they become worthless. Thus, in that case, investors would lose all their investments.
This article has been a guide to what is Buy and Hold Strategy. Here we explain its examples along with importance, advantages & disadvantages. You may learn more about accounting from the following articles –