What is the Buy-and-Hold Strategy?

Take part in the buy-and-hold strategy with Interactive Brokers or Robinhood.

Tired of swing trading stocks, trying to time the market or predict how a company will do on an upcoming earnings report? Consider switching to the buy-and-hold strategy.

This investment approach has proven successful for many of the world’s most renowned investors, including Warren Buffett who once famously said, “Our favorite holding period is forever” at a 1988 Berkshire Hathaway Inc. (NYSE: BRK.A) shareholder meeting. 

Does the buy-and-hold strategy work? Is it effective? How can ordinary retail investors put it into action? Read on for answers to these burning questions. 

What Does it Mean to Buy and Hold?

With a buy-and-hold strategy, investors purchase stocks, mutual funds or exchange-traded funds (ETFs) with the goal of keeping them in a portfolio long term. Unlike day and swing traders who book short-term profits, buy-and-hold investors will not sell until years, if not decades later when they need to fund income needs, such as for retirement. 

Investors who subscribe to the buy-and-hold strategy are less focused on the day-to-day fluctuations in their investments. Their expectation is that over the long term, returns will be positive and overcome any temporary losses. This approach requires high diversification in a portfolio, a long-term mindset and discipline to weather unrealized losses. 

Advantages of Buy-and-Hold Strategy

The buy-and-hold strategy is a simple, easily understandable and universally implementable investment approach particularly suitable for beginners. Here are some advantages of a buy-and-hold strategy for investors who decide to implement it. 

Less Investing Decisions

A significant advantage of the buy-and-hold strategy is that it requires making fewer investing decisions. Buy-and-hold investors don’t constantly analyze the market to make buy-or-sell decisions, which makes the investment process more passive, less stressful and cost-conscious. This approach is particularly beneficial for those who want to invest but don’t have the time or desire to monitor the markets closely. For a buy-and-hold investor, investing decisions amount to reinvesting dividends and rebalancing their portfolio. 

Focuses on Long-Term Success

Short-term fluctuations in the market, including downturns and periods of high volatility, are less concerning for buy-and-hold investors. These investors care more about the long-term prospect of their investments, which are usually selected for high quality and diversification. Instead of trying to time the market, these investors have the patience to ride out the market’s ups and downs, focusing on the potential for long-term success.

Simplified Taxes

Frequent trading can create a complicated tax situation, as every trade could potentially be a taxable event, with different tax rules applying to short-term versus long-term capital gains. With the buy-and-hold strategy, there are fewer trades to report, and if the investment is held for over a year, it may qualify for the lower long-term capital gains tax rate. This not only simplifies tax filing but can also offer significant tax advantages, which can boost long-term net investment returns. 

Risks of Buy-and-Hold Strategy

No investment strategy is risk-free. Despite its simplicity and accessibility, the buy-and-hold strategy suffers from numerous weaknesses that may not make it suitable for all investors.

Long-Term Market Decline

There is no guarantee that the investments held by a buy-and-hold investor will outpace inflation, beat the market or even be positive over time. Individual stocks run the risk of bankruptcy, and even the stock markets of countries like Japan have experienced decades of stagnant returns. For this reason, a buy-and-hold investor must be prepared to stay the course through periods of underperformance and diversify their portfolio as much as possible. 

Possible Missed Buying Opportunities

Because buy-and-hold is a passive strategy, it might lead to missed opportunities to buy undervalued stocks or stocks with momentum. Active traders, in contrast, are constantly analyzing market trends and could take advantage of promising new opportunities as they emerge. While the simplicity of the buy-and-hold strategy can be a benefit, it does mean that these opportunities may go unnoticed or unused and miss out on profits as a result. 

Inability to Benefit from Volatile Markets

Volatile markets can offer significant profit-making opportunities for active traders, as they can go short or use options to hedge their positions, benefit from downturns or produce income. In contrast, a buy-and-hold strategy with a long-only bias can only endure this volatility. Instead, you would maintain your position in your investments, regardless of market conditions. While this can protect you from making impulsive decisions based on short-term market movements, it might also limit your ability to maximize profits or limit losses during periods of market volatility.

How to Apply the Buy-and-Hold Strategy

Overall, the best way to apply the buy-and-hold strategy is with an investment that offers broad diversification and low fees. 

Broad diversification is essential because it spreads your investment across various sectors, regions and asset classes. This spread can mitigate the potential risk of substantial loss if any one investment performs poorly. In a buy-and-hold strategy, where investments are held for a long time, diversification can help smooth out returns over the long run.

Low fees are another crucial factor to consider. Because the buy-and-hold strategy is a long-term approach, high fees can significantly eat into your returns over time. Remember, fees can compound, much like your returns. Lower fees mean more of your money is working for you in the market, and this can make a big difference to your investment balance over the long term.

For this reason, investing in a broad-market index fund can be one of the best ways to apply a buy-and-hold strategy. An alternative is the target-date fund, which holds a predetermined mixture of stocks and bonds that adjusts to become more conservative in terms of risk as you age. 

Implementation of Buy-and-Hold Strategy in Various Markets

The buy-and-hold strategy benefits most from sustained bull markets. Research shows that the average bull market lasts around 6.6 years, with a cumulative total return of 339%. Hence, a buy-and-hold investor who stays the course throughout a bull market can reap significant returns. 

On the other hand, a buy-and-hold strategy can expect to face losses during a bear market, as it does not involve shorting or hedging to profit from a downturn or limit losses. Research shows that the average bear market lasts 1.3 years, with a cumulative loss of 38%.

A disciplined investor can successfully implement a buy-and-hold strategy in various markets by staying the course and reinvesting dividends. Given that bull markets last longer than bear markets, a buy-and-hold strategy can succeed if an investor can cope with volatility. 

Passive vs. Active Management

A buy-and-hold strategy is typically classified as a passive investment strategy because of its long-term focus and infrequent trading activity. Unlike active management, which involves frequent buying and selling decisions, passive management centers around maintaining a steady, long-term investment, regardless of short-term market fluctuations.

Labeling buy and hold as a passive strategy should not be misunderstood as a set-it-and-forget-it approach. While it does not require the constant analysis and decision-making typical of active management, it is still vital to periodically review your investments.

Active management elements within a buy-and-hold strategy might include rebalancing your portfolio, reinvesting dividends, evaluating the ongoing performance of your investments against your long-term goals and making necessary adjustments to your risk tolerance based on significant changes in your life or financial circumstances. 

In other words, while the buy-and-hold strategy is certainly more hands-off compared to active trading, it still requires oversight and occasional intervention to ensure it stays aligned with your financial goals and risk tolerance. So, while it’s more passive in its approach, it’s not entirely passive in its execution.

Buy-and-Hold Strategy: A Timeless Approach to Investing

The buy-and-hold strategy is a simple, time-tested investment approach that emphasizes a long-term mindset. Hallmarks of a buy-and-hold strategy are infrequent trading and tax simplicity. But it is not without potential risks, including missed buying opportunities and an inability to respond to volatile market conditions.

Successfully applying the buy-and-hold strategy involves choosing diversified investments with low fees, which can manage risk and maximize net returns over time. Despite being a passive strategy, it still requires active review and periodic adjustments to ensure your investment portfolio remains on track to meet your financial goals.

Whether you are a novice investor or a seasoned market participant, the buy-and-hold strategy can be a powerful tool in your investment arsenal, providing you with a steady approach to growing your portfolio long-term. 

Frequently Asked Questions