What is Buy and Hold Strategy?
The strategy of buy and hold is a long term passive investment strategy where the shareholders who purchased the shares continue to hold those stocks without considering the conditions prevailing in the market. 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 the strategy of buy and hold, fluctuations of short-term nature in the market, inflation, business cycles, etc are avoided and not considered as the deciding factor.
Example of the Buy and Hold Strategy
Let’s take a buy and hold strategy 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 on the basis of 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.
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After the tenure of two years, it is observed that there comes 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 bonds 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 rebalancing leaving the investments as it is i.e., no stock will be sold to maintain the ratio or otherwise and 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.
Advantages of the Buy and Hold Strategy
There are several different advantages of the buy and hold strategy providing the opportunity investors using the same. Some of the advantages are as follows:
- As the total number of transactions is lower in case of a strategy of buy and hold, so the brokerage, advisory fees, and sales commission are also low in this strategy.
- In case of a strategy of buy and hold, 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 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.
Disadvantages of the Buy and Hold Strategy
Limitations and drawbacks of the buy and hold strategy include the following:
- 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 tolerance of the investors should be high as the buy and hold strategy is easy to implement but difficult to follow correctly.
- As in case of a strategy of buy and hold, 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, then in that case also investors would continue holding that stock until they become worthless. Thus in that case investor 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 in order 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 per the strategy of the buy and hold, it is important that a person is investing in the portfolio which is well diversified.
Thus the strategy of buy and hold is the long term investment strategy which is ideal for the 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 in order to make the profits, investors in the buy-and-hold strategy keeps the stocks through both the bull 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 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 –