http://www.investopedia.com/terms/b/buyandhold.aspBuy and hold traders, also called long-term traders, are stock market investors who are buying stocks and holding them for a long period of time. This category most likely constitutes the largest group of people who are buying stocks, as it requires the least amount of time spent focused on the stock market.
Many buy and hold traders believe the best way to have exposure to the stock market is to buy great companies and hold them through any market condition. When they buy stocks with the intention of holding them for years, they are more likely to steer clear of trendy companies or up-and-coming, high risk businesses.
Benefits of buy and hold trading
On the whole, for long-term investments, time spent in buy and hold trading is much less compared to time spent on medium- and short-term investments. Very long-term investment is not time-sensitive, while in shorter-term investment, you have to take timely action.
Being a passive, long-term investor has many advantages over other types of trading:
- Fewer fees and commissions - Fees are often overlooked by traders. But when trading with small amounts of money, fees and commissions become even more important. Learning to control impulse trading and doing far less portfolio management may be the most profitable move a trader can make. Many believe that the big money in investing is made by diligent, long-term traders - buy and hold traders.
- Low maintenance - Buy and hold traders are not required to spend a lot of time keeping track of the stock market daily movements. The practice of watching daily price movements is highly counterproductive to the temperament a long-term investor must maintain.
- Less nerve-wracking - Companies that are typically chosen for buy and hold portfolios are less volatile than the average stock. Due to the lower volatility, there is less chance that a stock in a buy and hold trader’s portfolio will suddenly gap-up or gap-down overnight. The stock price fluctuations are more evident for the short-term trader - as buy and hold investors, time is on their side, and so if their stock goes down from where they bought it, they don’t have to worry as long as they still think the company is great.
- Bonus for dividend growth investors - If they are dividend growth investors, there is an additional bonus to being a buy and hold investor. As the dividend rate continues to rise, their yield on cost will increase as well!
- As the company grows, the dividends and bonuses are added to the net investment.
For example, look at the chart of Microsoft (Nasdaq: MSFT) below - $21 invested in 1 share of Microsoft's IPO on March 1986 is worth $10,368 when the share price reached $36 in the middle of July 2013 due to the stock being split 9 times. It has given 49,371% of returns in the buy and hold strategy.
- More shares may be allocated - Some companies convert the profit into shares and allot them to the shareholders. So the portfolio grows several fold in the long term.
- Tax benefits - One reason many traders prefer to buy and hold investments is that they defer capital gains taxes while the investment continues to earn additional money. It is actually enabling them to make money from the money they would have owed in taxes, which further increases their earnings over time.
- A proven strategy - The stock market record over the long term has shown, despite times of negativity, about a 9% annualized return over the past 100 years. It is common knowledge, as quoted by Benjamin Franklin: “Slow and steady diligence is the true way to wealth.”
Disadvantages of buy and hold trading
- The buy and hold strategy may give the appearance of a safer investment model, but no strategy is above risk. For example, traders who bought Microsoft in 2005 would have made less than 2% as of July 2013 on that investment (see the chart above).
- The other buy and hold problem is the onset of bear markets. If a buy and hold trader purchases a stock prior to a swift market decline similar to the ones in 1987 and 2002 and again in 2008, the traders may have to wait five to 10 years to break even on their initial investment. A buy and hold trader may be required to undertake more fundamental analysis before making an investment decision - which involves a great deal of parameters. Then, over time, these fundamentals can change - the political scenario, war and famine, supply and demand of the products, etc., can all affect the outcome of the profit.
Many of the shares that were good a decade ago may not be so good in today’s scenario.
With the apparition of the Apple iPad, the digital world took a different path. Until 2010, Advanced Micro Devices (NYSE: AMD) was one of the kings in the processor design and marketing for personal computers. AMD was not as efficient in terms of processing speed as a company such as Intel (Nasdaq: INTC), but had significantly cheaper costs. Now, however, this is a company battling to survive!
3. A buy and hold trader will not be able benefit from the price swings when holding the shares for long periods of time, whereas in shorter-term investment - as with swing trading - the buy and hold trader can catch most of the swings. The sum of the price swings will be several times more than the total movement of the price.
4. One commonly overlooked problem for the buy and hold traders is the fact they have to buy and hold. Making money in the market is not like working a job wherein more effort equals greater results. So, traders will have to fight the urge to overtrade, as the key to a successful buy and hold strategy is quality, not quantity.
When to sell
A buy and hold trader should know when the strategy isn’t going to work or when it makes more sense to sell the stock they intended to hold until retirement or later. There are exceptions to every rule, including the buy and hold strategy. Here are a few situations when they may decide to sell their stocks rather than hold them:
- Company files bankruptcy.
- CFO indicted for accounting problems or theft.
- Company does something that goes against personal values or beliefs.
Buy and hold trading is simply another method of investing and profiting in the stock market - the long-term investment strategy.
For a small investor who does not care to analyze the market, does not know to shift sectors, cannot buy on the lows and sell on the highs, it is better to buy blue chip or budding blue chip company stocks, with a good spread, and hold them for a long period of time. At the extreme, such traders will hold the stocks indefinitely, and sell only if they need that money.
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