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If you are the kind of investor who likes to read a financial news outlet at least a few times a week, you probably know that Warren Buffett has one or two good ideas. He’s famous for buying at exactly the right time and making every effort to just not sell anything.
This would be colloquially known as a “buy and hold” investing strategy. If you’ve heard this term before, you may know a bit about it.
Let’s get further into some of the details and explain what it is for those who don’t know and how best to implement it for the best potential to profit.
What Does Buy and Hold Mean?
“Buy and hold” is a bit self-explanatory because it literally describes the method of buying a stock and holding it for a long period of time.
We brought up Warren Buffett right from the start because he is famous for buying stocks and holding them for long periods of time.
>> Learn More: How to Start Investing
What Is a Buy and Hold Strategy?
A buy-and-hold strategy is very much a passive method of investing, though not completely passive. If you’re the kind of investor who prefers to be very careful about investment choices and not have to take special care of your portfolio constantly, this might be the strategy for you.
Since you only have so much capital to deploy, it’s also helpful because you only have to research a few stocks you want to buy.
After that, the idea is to hold the stock or other assets and let the capital grow for years or decades.
How the Buy and Hold Strategy Works in Investing
We mentioned that buy and hold is mostly passive investing, and that’s because no stock grows forever and ever into infinity.
There is some element of value investing involved in buy and hold, depending on who you talk to. You will ideally buy a stock that is underpriced but still capable of performing well over a long period of time.
However, no stock grows forever. It’s best to implement a hard limit on a stock as a percentage of your portfolio.
We’ll get into an example soon, but this means that you don’t want a stock to be too heavily weighted in your portfolio.
If a stock grows from about 10% of your portfolio to, for instance, 25% of your portfolio, this could represent a point where you might want to rebalance the portfolio.
These are just made-up numbers, but the idea is that you don’t want too much of your portfolio weighted towards any single asset.
Pros and Cons of Buy and Hold Strategy
- Simplicity: No requirement to constantly check your portfolio and make small adjustments. One or two checks per year should be enough management.
- Tax Advantages: Short-term capital gains are much higher at the moment than long-term capital gains. If you hold a stock or asset for longer than a year, you qualify for the lower long-term capital gain rate.
- Lower Short-term Risk: If catastrophic events occur, such as the lockdowns in 2020, you can typically worry less because, while you might take a short-term hit, the plan to stay in for the long game usually pays off.
- Less Flexibility: Even though you can theoretically sell out of a position any time, as long as it’s not locked up in some way, a good buy-and-hold strategy can only work if the money stays invested.
- Not Completely Passive: A good buy-and-hold strategy will require some maintenance. After all, if a single stock rises to such a degree that it is weighted far more than the rest of your portfolio, that increases the likelihood of losing money if you don’t at least check in once or twice per year and re-balance as necessary, always remembering not to sell before a year to reduce tax requirements.
- Price Risk: Just because you buy and hold a stock does not mean it is guaranteed to go up. Any stock can drop significantly for many reasons. The company could even declare bankruptcy. Just remember that every investment comes with risks.
Example of Buy and Hold Strategy in Investing
Let’s say that you want a portfolio or only five stocks, and you will initially distribute a $50,000 portfolio evenly among the stocks.
Here’s our made-up portfolio, based on the most recent closing prices:
- AAPL – 67 shares at $149.10/share – $9,989.70
- TLSA– 13 shares at $717.17/share – $9,323.21
- MGNI – 343 shares at $29.09/share – $9,977.87
- DOV – 58 shares at $171.64/share – $9,955.12
- DIS– 55 shares at 181.08/share – $9,959.40
These all represent about 20% of the portfolio but not over since you only have $50,000 to invest.
Now, what happens if all of the stocks grow 10% this year, but another company offers to buy MGNI, and the stock nearly doubles to $50 per share? Let’s look at the numbers:
- AAPL – 67 shares at $164.01/share – $10,988.67
- TLSA – 13 shares at $788.88/share – $10,255.53
- MGNI – 343 shares at $50.00/share – $17,150.00
- DOV – 58 shares at $188.80/share – $10,950.63
- DIS – 55 shares at 199.19/share – $10,955.34
Your total balance is now $60,300 and change, and MGNI represents almost 30% of your portfolio.
With that kind of growth in such a short time, especially given the type of event, it may be worth selling some of the MGNI and distributing it evenly among the other stocks. This is an example of rebalancing a buy-and-hold portfolio.
>> Learn More: How to Make Money in Stocks
Is Buy and Hold Still a Good Strategy?
Some would argue that the speed of growth makes buy and hold a difficult sell these days.
Others might say that buy and hold is supported by what’s called the Efficient Market Hypothesis, where everything is already figured into a stock’s current price.
Either way, it really depends on your investing style. With the right kind of attention and research, buy and hold can still work. Just ask Mr. Buffett.
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Is the Buy and Hold Strategy in Investing Safe?
Yes, much safer than scalping or day trading. If you’ve done research on the company, it’s just that much safer.
Bottom Line: What Does Buy and Hold Mean?
Buy and hold is a solid strategy of buying a stockand holding it for a long period of time.
Although it isn’t completely passive, it allows mostly passive investors to enjoy the benefits of long-term growth and still diversify somewhat by buying stocks or indexes that help balance the portfolio’s exposure.