What is Buy and Hold Strategy?
Buy and hold strategy refers to the investment strategy of investors where they buy/invest in securities for a long time with no intention to sell in short period and it refers to investment for a long period of time by retaining the investment usually ignoring the ups and downs in market price in short period.
Investors following this strategy of Buy and hold rely on the company’s fundamental analysis in which they are planning 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 management of the company, etc.
While going for this strategy, fluctuations of short-term nature in the market, inflation, business cyclesBusiness CyclesThe business cycle represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate., etc. are avoided and not considered as the deciding factor.
Buy and Hold Example
Let’s take an example of Mr. X has $ 500,000 to invest in different areas and prepare the portfolio out of them to earn the maximum amount of return based on the different parameters suiting to its requirements such as risk, goals, and the tax. 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 $ 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 the 50% to the 75% and reducing the proportion of bondsBondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually. and risk-free assets to 10% and 15% respectively.
- Now, as per the prevailing situation investor has two options which he can follow. Firstly he can maintain the original ratio of the different class of assets. For this, he has to sell some of its stocks so that the same ratio can be maintained. In this case, he is not holding the stocks for a long period of time and thus not following the strategy of buy and hold.
- 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 or otherwise. 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 of time and thus following the true strategy of buy and hold.
Mr. X believes in the strategy of buy and holds as he believes that 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 holds the stock for 11 years and sold all the shares in July 2019 when the prices of the stock 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 6 years. It is the strategy of the buy and holds, which worked very well in the case of the purchase of stock of Facebook by Mr. X, thereby giving him excellent results.
- As the total number of transactions is lower in the case of a strategy of buy and hold, so the brokerage, advisory fees, and sales 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, long term capital gain will be applicable. The rate of tax 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 prices of the stock and considered 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 risk toleranceRisk 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. of the investors should be high as the buy and hold 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 in case any negative event occurs with respect to market or stock. Like if there comes any negative news with respect to stock purchased by the investors, and the company becomes bankrupt. In that case, also investors would continue holding that stock until they become worthless. Thus, in that case, investors would lose all its investment.
Important Points to Note
- Even though one holds the securities for the long-term in case of a strategy of buy and hold, 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 the stocks or bonds, but at the same time, they apply to the real estate sector as well, where houses are purchased by the investors without flipping them. In this case, generally, a mortgage will be taken by the investors to gain the benefits of leverage.
- While making the investment as this strategy, it is vital that a person is investing in the portfolio, which is well diversified.
The strategy of buy and hold is the long term investment strategy, which is ideal for investors who do not have that time to keep following up their investment portfolio. Rather than treating the stocks or bonds as a short-term vehicle to make the profits, investors in the buy-and-hold strategy keeps 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 prices of the stock and considered the short-term fluctuations in the market. In this strategy, it is required that investors should be able to handle the impact of the downturns and should not take wrong decisions in the panic.
This article has been a guide to what is Buy and Hold Strategy and its definition. Here we discuss examples of Buy and Hold Strategy along with examples, advantages & disadvantages. You may learn more about accounting from the following articles –