8-05 Buy and Hold

8-05 Buy and Hold

“Buy and Hold” is the polar opposite strategy from day trading. Buy and Hold investors spend all of their time researching the fundamental strengths of a company, making sure it is the best at what it does and has the resources to continue to be. When they buy a stock they never intend to sell it.

A “Buy and Hold” investor effectively ignores the stock’s price movements, the ups and downs do not really matter. So long as the fundamental strengths of the company that caused them to make their original investment are in place, they continue to hold the stock.

Who Uses Buy and Hold?

“Buy and Hold” might sound unappealing to most new investors. Buy a stock and ignore if the price drops? It could be the recipe for disaster! However, it does have some extremely strong proponents.

Warren Buffet

Warren Buffet never buys a stock he intends to sell, and is very public that his holding period is “forever”. Being one of the richest men in the entire world, it would be hard to argue he is wrong.

When we compare his investment company, Berkshire Hathaway, to the S&P 500 from June 2020 to June 2021, it is hard to argue with his results (the blue line is Buffet’s investments, orange is the S&P 500):

Buffet routinely matches or out-performs the market as a whole, explicitly by focusing on companies that have long-term growth potential that he wants to be holding “forever” – and completely ignoring companies that have short-term growth potential. He might miss out on some price spikes, but it means he also misses out on crashes too.

Financial Advisors

Just about every financial advisor or personal financial planner will advocate anyone investing on their own should go in with a “Buy and Hold” mindset and advise against regular “trading” of stocks. You will be very hard-pressed to find a financial guru or personal finance textbook that would advise the average investor to start looking at day trading, swing trading, or penny stocks.

There are some very strong reasons for this too, from a personal finance perspective!

Advantages to Buy and Hold

While the other short-term investing strategies might be interesting if you are trying to make a quick profit, “Buy and Hold” has very powerful advantages that make it the most successful long-term strategy for investing.

Tax Advantages

When you buy and sell a stock in the same day, it is called “Day Trading”. When you buy and sell a stock in the same year, it is called “Short Term Investing”, and any gains you make on the trade are taxed at a “Short Term Capital Gains” rate – which is basically an income tax level designed for day traders and short-term investors.

However, if you buy a stock and sell it more than a year later, it is considered “Long Term Investing”, and “Long Term Capital Gains”. The gains you make on these trades are taxed at a much lower rate. This tax rate was designed for retirees living off their long-term investments.

The actual tax rates vary by year (because of changes in tax law) and how big the gains are. To give a rough idea of the difference, in 2021 if you were a single person investing, this is what you would pay:

If your profit was…Short-Term TaxLong-Term Tax
$5,000$500 $                           –  
$15,000$1,800 $                           –  
$50,000$11,000$7,500

In other words, there is no tax at all for modest returns made over a year, but a pretty big tax bill for your short-term gains. This gives a powerful incentive to ignore small short-term losses if you are still sure of a stock’s long-term potential.

Peace of Mind

A “Buy and Hold” strategy means that you need to be a very savvy investor when making your initial “buy” decision, but you do not have to ever worry about market timing or constantly keeping up with the news on every stock in your portfolio. After all, there are other things going on in your life that you would much rather be doing. Some of these things may include:

  • Working a job to earn money
  • Going out for a walk
  • Enjoying a cup of coffee
  • Travelling to another country
  • Enjoying a nice dinner out with your significant other
  • Playing with your pets
  • Watching a movie
  • …plus dozens of other potential activities!

If you are actively day trading, swing trading, or worrying about your short-term gains, your portfolio will always be at the back of your mind. Did I make or lose money today? What does that mean for my weekly gains and losses? What are my monthly profits?

Adopting a Buy and Hold strategy effectively removes your portfolio from your day-to-day worries. Instead, you would check in every month or so (basically whenever you make another cash deposit that needs to be invested) for another round of research to make sure the companies you have invested in are as strong as you thought they were.

Buy and Hold Downsides

While “Buy and Hold” definitely has some major advantages, most investors would not advocate such an extreme approach. Buy and Hold assumes that you will never be selling this stock unless something fundamental to the company changes, but that level of dedication means that you might not be paying attention when something does change.

Making heavy use of “Stop” and “Trailing Stop” orders would be frowned upon by a true Buy and Hold believer, but most investors consider cutting your losses to be a more prudent approach.

Mark's Tip
Mark

In spite of the conventional wisdom that buy and hold is the best way to invest, many people are starting to question this strategy. Because times are changing so fast, and both technology and consumers’ buying behavior are changing so fast, it appears that business cycles are getting shorter and that a successfully managed investment portfolio needs to react to these market conditions.