The buy-and-hold strategy is a long-term, passive investing strategy in which shareholders continue to hold onto their stocks regardless of market conditions. This is in stark contrast with an active investing strategy, which involves almost constant monitoring of market conditions and frequently entering and exiting positions.
Namely, if the stock market goes down in the near term, that's an acceptable outcome. It’s the longer-term trend that should be positive.
In this article, define the buy and hold investment strategy, and discuss its advantages and disadvantages as well as potential returns.
Defining the Buy and Hold Investment Strategy
Buy-and-hold investors also believe it's very efficient in terms of fees and commissions. Stocks are purchased and only sold when money is needed by the investor, thereby minimizing brokerage commissions.
In addition to lowering costs and ignoring short-term declines, since stocks are fairly priced, attempting to buy low and sell high is a waste of time. It’s more effective to buy a stock and hold onto it over the long haul.
In extreme circumstances, a buy-and-hold investor would never sell shares of their stocks. If the market declined sharply, they would merely wait for the market to bounce back eventually.
Advantages and Disadvantages Associated
- Ease of implementation – Since the technique involves the one-time selection and purchase of stocks, it's an easy strategy to adopt. Once the stock portfolio is assembled, there is no need to monitor stock prices over time or worry about short-term market fluctuations.
- Eliminates timing decisions – Some investors try to predict when a bear market has bottomed out or a bull market has run its course. Buying and holding stocks eliminates the possibility of making a series of poor timing decisions.
- Cost efficiency – Sales commissions and brokerage fees are lower since the total number of transactions is minimized.
- Tax efficiency – Long-term capital gains are taxed at a lower rate than short-term ones.
- No limit on losses – Since the technique calls for holding onto stocks regardless of price signals or news, there is no limit to possible losses. For example, despite warnings that a company may be on the verge of bankruptcy or facing a financial crisis, the investor would continue to own the shares of stock until they were worthless, thereby losing the entire investment.
- Risk tolerance – Investors need to have high-risk tolerance to avoid buying high and selling low in cases of severe market downturns.
Examples of Historical Returns
Using historical data on average returns can help illustrate the workings of the buy-and-hold investing strategy. The figures show that the average annual return fluctuates throughout the decades, but ultimately, holding on to equities of companies with strong business fundamentals is worth it. Because of compounding, even seemingly low average annual returns can lead to significant long-term growth in investments over time.
Here’s a table that illustrates the average annual return of the S&P 500 Index throughout the past 60 years, assuming all dividends were reinvested.
1970 | 1980 | 1990 | 2000 | 2010 | 2020 | |
|---|---|---|---|---|---|---|
1960 | 7.83% | 7.88% | 9.76% | 11.65% | 9.58% | 10.24% |
1970 | 7.89% | 10.68% | 12.90% | 10.00% | 10.71% | |
1980 | 14.89% | 16.22% | 11.25% | 11.83% | ||
1990 | 15.88% | 8.78% | 10.33% | |||
2000 | 0.85% | 6.76% | ||||
2010 | 13.90% |
In the highly unlikely scenario that an investor has been holding on to their investment for 60 years, from 1960 to 2020, their average annual return would be 10.24%. However, since they have been holding for such a long time, the seemingly low annual average return translates to a total return of 38,070.10%. Simply put, if the investor invested just $100 in the S&P 500 Index in 1960 and reinvested all their dividends, their investment would be worth $38,170.10 by 2020.
In a more likely scenario, an investor invested $100, reinvested all dividends in the S&P 500 Index in 1990, and held to it until 2020. The average annual return of their investment for those 30 years is close to our previous investor at 10.33%, but since they have been holding for half the time, their total return by 2020 would be more than ten times lower at 2,007.31%. Their original investment of $100 would be worth $2,107.31 in 2020.
Finally, the average annual return rate of the S&P 500 Index for the decade between 2000 and 2010 was only 0.85%. This period is often called the "Lost Decade" for investors due to the low returns. If an investor had invested $100 and reinvested all dividends, the total return they would get by the end of the decade would only be 9.78%, growing their initial investment to only $109.78. In contrast, the average annual return between 2010 and 2020 was 13.90%, which translates to 318.65% total return and would grow an initial investment of $100 to $418.65 if all dividends were reinvested.
Real-World Examples of Buy and Hold Investing
Warren Buffet, a living legend in the world of investing, is a prime example of the success of the buy-and-hold investing strategy. Known for his accomplishments in the investment world, one famous Buffet quote perfectly encapsulates his approach to buy-and-hold investing:
"Our favorite holding period is forever."
The best way to understand why Buffet insisted on holding investments for the long term is to examine the popular case study of his investment in Coca-Cola.
1989 was the first time Warren Buffett's Berkshire Hathaway invested in The Coca-Cola Company. The initial investment was worth just under $600 million and secured 14 million shares in the deal. Since then, the company has split its stock four times.
In 2021, Berkshire Hathaway owned 400 million Coca-Cola shares, estimated at around $25 billion. The estimated cost basis for getting those shares is approximately $1.3 billion.
What is important to note here is that Coca-Cola shares did not outperform the market throughout the entire period between 1989 and 2021. For example, Coca-Cola shares declined by almost 28% between 1998 and 2006, while at the same time, the S&P 500 Index increased by more than 46%.
But in the long run, from 1988 to 2021, Coca-Cola’s shares outperformed the market and increased their price 25-fold, while the S&P 500 Index only grew 19-fold.
Buy and Hold Real Estate
Buy and hold is also one of the most commonly used investment strategies in the real estate market. In fact, properties are the ideal investment for buying and holding as they have both ingredients necessary for success in the long term:
Opportunity for steady cash flow from rental income
Potential for appreciation over time
Simply put, the investor can buy a house, rent it out, use the rental income to cover the financing and property costs and sell it at a higher price further down the line.
Of course, this is easier said than done, and the success of real estate investments depends on multiple other factors, but in essence, buy and hold is a viable approach in the real estate market.
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