Capitals markets, namely debt and equity, are the primary routes by which companies are able to raise long-term capital. However, they are often extremely volatile over short periods of time, causing investors to overreact and become irrational. The intelligent investor is able to harness his or her emotions and make sound decisions that are consistent with the business fundamentals present in the marketplace.

Equity Basics
A stock share is an ownership claim on the cash flows of a public company. These shares are traded on stock markets, which are discounting mechanisms that are constantly valuing stocks at different prices. While a stock's price may demonstrate extreme volatility over a day, week, month or even year, the stock market is like a casino game rigged towards the players. Investing with a conservative, passive strategy is sure to yield satisfactory results.

In the United States, the Dow Jones Industrial Average (DJIA) yielded an annualized 7.0% total real return from 1950-2009. As opposed to the nominal return, real return is adjusted for inflation, reflecting aggregate price changes that transpired during the time period. Moreover, total return assumes that all dividends are reinvested, a critical aspect of maximizing return. It sounds easy to make money, doesn't it? Well, yes and no.

It is important to note that the DJIA historical return is an average of the yearly total return. Over relatively short time periods, the stock market has dropped in value by massive amounts, such as a 27% loss from 1981 to 1982 or 49% loss from 2000 to 2001. Fortunately, these bear markets are offset by bull markets of greater magnitude. For example, the great bull market of the 1990s yielded a 14.7% total real return. Only investors with prolonged time horizons for their investments are sure to weather this kind of extreme volatility.

Properly diversifying is crucial when seeking to minimize the risk of an equity portfolio, especially in the modern financial world. Beta, a variable that describes the systematic risk of a security or portfolio in comparison to the market as a whole, has never been higher between the U.S. and international markets. In other words, markets around the world are more interconnected than ever before because of globalization. Shocks to a financial system in one nation can imply serious implications to economies globally. Thus, keeping beta low through an internationally diversified portfolio is critical to the buy-and-hold investor.

Another important buy-and-holding investment strategy is indexing. Indexing is investing in index funds, or equity funds that are intended to represent an index. As indexes are often correlated with the economic health of a region or industry (such as SPDR S&P 500), an index fund investor is almost guaranteed to see returns over long periods of time.

Index investing is also a traditional way of diversifying a portfolio. While individual stocks are likely to fluctuate many percentage points over short periods of time, since most index funds are diversified, their volatility is reduced substantially compared to a stock's. An index fund's yield is not likely to be as high as a given individual stock's, but this comes at a sizably reduced risk. Accordingly, indexing is a crucial aspect for investors subscribing to a conservative, buy-and-hold strategy.

Holding Your Position
It's been said that an investor's greatest enemy is himself. Humans often attribute more weight to their emotions than rational thought. Accordingly, an investor can easily lose sight of his or her logical, methodical investing strategies if some financial calamity takes place. When a stock's price is appreciating, an investor is emotionally driven to buy, just as when a stock's price is depreciating, an investor is emotionally driven to sell. However, these are the worst times to enter and exit the market. Instead of buying low and selling high, the mantra of any successful market player, human emotional responses naturally condition investors to enter the market before the crashes and exit the market before recoveries.

A truly great investor is able to ignore what his emotions are telling him. With an investment time horizon of many years, the worst thing a buy-and-hold investor can do is realize his losses by liquidating his equity position. Stay the course, investing in business fundamentals at the right price.

Portfolio Rebalancing
Another time tested buy-and-holding investment strategy is portfolio rebalancing. To rebalance one's portfolio, an investor first sets the percentages of his portfolio allocations to what he thinks is best suited for each different investment vehicle. Of course, these percentages are different for every investor based on his investment personality, such as his liquidity needs, time horizon and relative suitability.

Now for the actual rebalancing. Take for example the classic portfolio structure is 50% stocks and 50% bonds. Every few months or so, an investor can sell off stock and buy bonds, or buy stock and sell bonds to reach these pre-determined percentages. Thus, an investor can ensure that he or she is not caught up in market speculation. If the prices of stocks rise to meteoric heights, a sell signal is triggered and the investor will realize these capital gains. If the stock market plummets, a buy signal goes off and the investor enjoys extremely discounted stock prices. As you can see, portfolio rebalancing is a method of ensuring that the buy-and-hold investor is not caught up in speculative crazes.

The Bottom Line
Buy-and-hold investing is not for the faint of heart. It can be extremely unsettling for an investor to stand by as the value of his or her portfolio erodes. The buy-and-hold investment strategy requires investors to disregard their emotional responses to market movements. If these investors can resist their emotional temptations, they can achieve outstanding success. Of course, while buy-and-holding investing has seen some success since the inception of the stock market, past investment performance is not indicative of future returns.

Related Articles
  1. Investing Basics

    5 Ways to Double Your Investment

    So if you want to go double, consider these five classic strategies to help turn your vision into a reality.
  2. Technical Indicators

    Explaining Autocorrelation

    Autocorrelation is the measure of an internal correlation with a given time series.
  3. Term

    Public Goods & Free Riders

    A public good is an item whose consumption is determined by society, not individual consumers.
  4. Mutual Funds & ETFs

    4 Mutual Funds Warren Buffet Would Buy

    Learn about four mutual funds Warren Buffett would invest and recommend to his trustee, and discover detailed analysis of these mutual funds.
  5. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  6. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  7. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  8. Bonds & Fixed Income

    High Yield Bond Investing 101

    Taking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
  9. Retirement

    How Robo-Advisors Can Help You and Your Portfolio

    Robo-advisors can add a layer of affordable help and insight to most people's portfolio management efforts, especially as the market continues to mature.
  10. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  1. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  3. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  4. What fees do financial advisors charge?

    Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
  5. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  6. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!