Buy and Hold Investing Explained

Have you ever heard the saying, “Good things come to those who wait”?

For some, it’s the title of a popular song. Others recall hearing these words during a tongue lashing from their parents. Regardless of where you’ve heard these popular words, it’s safe to say that they hold some truth.

Passive investing has proven, time and time again, that investing in the long-term holds benefits that go beyond (relatively) definite future returns. This investment strategy offers low stress and higher security, a major advantage over riskier, active strategies.

Buy and hold investing represents passive investing well and we’re about to show you why.

With the buy and hold strategy, an investor will strategically place their capital in investments they believe will perform well over the long term. Then, they leave this capital where it is, even if the market experiences ups and downs.

Although this may sound dangerous, buying and holding is one of the top investment strategies recommended by legendary investors Warren Buffet and Jack Bogle. Warren Buffet even attributes his $89 million net worth to this investment method.

But, buy and hold investing isn’t always sunshine and roses, as it is a strategy that requires significant research before opening an investing position. It also requires the investor to stay strong and not panic when their stock declines in value from time to time.

Think buy and hold investing sounds like a strategy that might fit your portfolio? Read on to learn about the pros and cons of buy and hold investing and how you can get started.

Buy and Hold Strategy Explained 👨‍🏫

Unless you have a crystal ball, it is impossible to predict how the stock market will perform. Even the best swing and day traders depend on educated guesses – and a little bit of luck – to determine which way prices will go.

Since most investors aren’t comfortable basing their investments on guesses – no matter how educated – it’s no surprise that buy and hold investing has grown in popularity over the last few years.

This strategy offers the promise of progress with notably lower levels of risk. Plus, many investors like the ‘love it and leave it’ mentality, which backs buy and hold investing.

However, before deciding to go all-in on this strategy, let’s break down how it works and when to use it.

What is a Buy and Hold Strategy? 📚

Buy and hold is a long-term investment thesis where investors purchase securities to keep them for the long term. They do this because they believe that these assets will gain value over a long period of time.

The buy and hold strategy can be used to invest in a variety of securities, giving investors ample choice. Many investors opt for exchange-traded funds (ETFs) or other index funds as these tend to carry less risk because of their diversification.

Once the investor has chosen their position, they will not attempt to move the money to another investment for a long time. Instead, they will leave the capital in the investment even as the market shifts to include negative and positive changes. 

Typically, buy-and-hold investors leave the investment for years without closing the position. Some investors even leave their position for decades, making this one of the longest-term types of investing.

How Does Buy and Hold Work? 👷‍♂️

Getting started with a buy-and-hold investment is very simple: it begins with research. Like any other type of investing, it is critical to know the ins and outs of a company and the possible risks of investing in it before opening a position. 

Many buy and hold investors will perform stock analysis on a sector or company of interest. They do this to ensure they can trust a company and the products and services this company sells, as these factors will directly affect future growth. Sometimes, investors will specifically look for value stocks or growth stocks to make the most of their investment.

When the analysis is complete, the investor will open a position on the company they have chosen, or if they want to invest in a sector as a whole, purchase an ETF through a reliable ETF broker.

Following the opening of a buy-and-hold position, the investor will continue to keep that position open for years. They will likely only change or close their position if there is a major change to the value of the stock or the company changes to the point that the investor no longer believes in the product.

Many investors do not check on these investments daily because there are few reasons to change or close a buy-and-hold position. Instead, they keep an eye on the news for significant events that could affect their investment, only checking them when one of these events may be concerning for the health of their investment.

When is a Buy and Hold Strategy Used? 🤔

Investors should only employ a buy-and-hold strategy with capital that the investor won’t need for an extended time. Buying and holding is not very profitable if only used for a few months – hence why it is essential to let these investments mature for a long time.

Because the capital invested in a buy and hold strategy needs to be money an investor can do without, this strategy is ideal for people saving for retirement or another event decades down the road. 

Of course, this isn’t the only time to use a buy-and-hold strategy, but it is one of the best. Investors who don’t want to deal with the stress of active trading also prefer to adopt this strategy.

Retirement Accounts that Buy and Hold 🧓

As mentioned above, saving for retirement is ideal for adopting the buy-and-hold strategy. Many investors do so by opening a specific type of account that lends itself to this type of investing.

Traditional IRA ☑

A traditional IRA is a popular buy-and-hold investment account because of its tax benefits which help the account holder. Not only does money usually enter the account tax-free, but if income is low enough, the investor can even receive tax deductions for the amount of capital they put into the account. 

Because the individual chooses to put their money into the IRA tax-free, they will only pay income tax when they begin to withdraw from the account. This can be helpful if the investor plans to be in a lower tax income bracket in the future.

They can usually begin withdrawals around retirement age(59 and ½ at the earliest), but by law must start withdrawing money from the account once they reach the age of 72. This account type is a buy-and-hold investment strategy because there is a penalty if someone wishes to withdraw money before they reach the minimum age.

Therefore any money put in a Traditional IRA must be money that the investor does not intend to need until they turn 60.

Roth IRA ☑

A Roth IRA is similar to a traditional IRA in that it is an investment account. Still, unlike the traditional IRA, all money put into this account must be taxed before being deposited. Although this may not sound very beneficial, it allows the account holder to take tax-free deductions once they retire. 

This employs the same sort of buy and hold strategy as a traditional IRA account but should be used by those individuals who believe they will be in a higher tax bracket when they reach retirement age–which is why they would rather pay the taxes on their money now. Most traditional, established stock brokers also offer Roth IRAs.

Whether the investor chooses a Roth IRA or Traditional IRA, when they deposit money into either of these accounts, it will be used to open investment positions of the account holder’s choosing.

401(k) ☑

A 401(k) is a special type of retirement account that individuals can contribute to directly from their paycheck, as long as their employer has a 401(k) plan. Employees can pick between the Traditional IRA account or the Roth IRA account, reaping the tax benefits of the option they choose. 

These accounts follow the same rules as any other type of retirement account previously mentioned; the only difference is that an employer will typically match contributions under a 401(k) plan, which gives the investor “free money” depending on the contribution match amount.   

However, this benefit has a downside, as joining an employer-sponsored 401(k) plan means the employee will have to choose from a range of pre-selected investments. The selection usually includes a mix of index and mutual funds.

An Example of the Buy and Hold Strategy 📝

Still not sold on the buy and hold method of investing? Here is an example of how it works.

It’s 1997, and Jenny is interested in investing in a company. She specifically wants to make an investment she doesn’t need to check on daily. She only has $100 to spend, so she can’t pick anything too expensive.

Jenny does a little bit of research and finds that Amazon.com seems to be a promising company, and she believes the internet is the future. So in August 1997, Jenny put her $100 into Amazon (AMZN), which cost just $2.34 a share. She buys a total of 42 shares. 

In 1998 and 1999, Jenny was excited as technology stocks soared. AMZN stock is now $37 a share. Although her original investment has multiplied, Jenny is doing the buy and hold strategy, so she does not close her position even though it is a bull market.

In 2000, Jenny watched as the dot-com crash cost investors millions, and her positions began to decline. Although the following years were a bear market, Jenny left her position open because she believed that Amazon would eventually bounce back.

In 2017, two decades since Jenny’s original investment, each share she bought in AMZN was worth $1,028. So, that means her 42 shares amount to $43,176.

Jenny could have closed her position when the market went up or down, but because she put in money she did not intend to cash out any time soon, she ended up earning a substantial return using the buy and hold method of investing.

Buy and Hold vs. Active Investing: Which One is Better? ⚔

Buy and hold is a passive investment strategy, meaning that the investor does not check or change his investments regularly. The opposite is active investing, a type of investing where a fund manager evaluates investments daily and makes changes as needed. 

These two styles of investing are entirely different from one another, and the one that is better for an individual will depend on their lifestyle. For example, someone who enjoys following daily trends in the market and doesn’t mind making regular changes to their portfolio is better suited for active strategy.

On the other hand, an individual who doesn’t have time to check into their positions each day and make changes when needed will do better with the buy and hold strategy as they only need to research a company once and then sit back and enjoy the ride. 

So when inquiring as to which strategy is better, the answer will depend on the investor’s desire to be involved in their investment regularly and the amount of time they have available to devote to their portfolio.

The Tax Benefits of Buy and Hold 💰

One of the main reasons many investors choose the buy and hold strategy is that it comes with many benefits regarding taxes. Not only are there the retirement accounts we’ve mentioned that can postpone tax burden, but buying and holding can also save an investor from other types of taxes. 

First, buy and hold strategies can save an investor from paying short-term capital gains taxes. These taxes only apply to stocks held for less than a year, thus exempting buy-and-hold investors as they keep their positions open for longer than a year.

Short-term capital gains taxes are no laughing matter as they start at 10% and can extend up to 37%, depending on the investor’s income level. This amount is significantly more than the long-term capital gains tax, starting at 0% and ending at 20%, depending on income level.

Think of it this way: an investor deposited $20,000 into a fund on January 31st, 2021, and by December 20th, 2021, the investment has doubled to $40,000. The investor must now decide whether to cash out the investment or continue to keep the position open.

If the investor cashes out now, they will owe at least 10% of what they made to the IRS (or more) So, while they made a $20,000 net profit, $2,000-$7,400 of this will have to go directly to the government, which is a hefty portion of the investor’s return. Not to mention that this doesn’t include the fees charged by their brokerage platform.

But if they wait until they have held the position for at least a year, there is a chance that their capital gains taxes could amount to 0%. As a result, the investor could walk away from the position with around $20,000 – saving them thousands of dollars, which they can use to invest.

Advantages and Disadvantages of Buy and Hold ⚖

Even though it is advantageous, tax-wise, to engage the buy and hold strategy, it isn’t always sunshine and roses – like anything else in life. While there are many advantages to this tactic, there are also several disadvantages.

Advantages of Buy and Hold 🌟

The main benefit of a buy-and-hold investment strategy is its simplicity. All an investor has to do is conduct their research once, select their investments, open a position and hold. There is no need to check prices or make daily changes to their portfolio.

This simplicity leads to a waterfall of other benefits as the infrequent trading incurs fewer fees on the brokerage platform and protects against emotional trading. Emotional trading happens when an investor opens or closes a position based on fear or greed. 

Buy and hold investors often don’t feel these emotions as they invest with money they don’t expect to use for years, and they don’t panic when there is a bear market because it is part of their plan. They also don’t spend hours agonizing over timing the market–which is a significant stressor for active investors.

Add in the tax benefit of not having to pay short-term capital gains taxes, and it can be easy to see why many investors choose this investment tactic. 

Disadvantages of Buy and Hold 🚧

Unfortunately, while buy and hold is a simple strategy to implement, it is also a strategy that could quickly go wrong in a few different ways —starting with the fact that it ties up an investor’s capital.

When an investor’s money is tied up in buy and hold, they can’t move it to another investment–which means they may have to pass up an excellent opportunity to invest. But beyond that, their capital could be tied up in a bad investment that the investor believes will eventually get better, which may never happen.

Plus, buy-and-hold investing is not risk-free. For example, an investor could invest for 40 years in a company performing well, only to wake up on the day they plan to sell to find the company has gone under, wiping out their investment.

The good news is that there are ways to minimize these disadvantages to protect the investor from disaster better. Such regular rebalancing of their portfolio to eliminate duds and diversify by investing in index funds or multiple companies.

In Summary:

HODL: Buy and Hold for Cryptocurrency 🪙

One of the primary industries where investors apply the buy and hold strategy is cryptocurrency. A passive approach to cryptocurrencies is more popular since these digital assets are highly volatile – even dropping multiple percentages in a single day. If investors allow themselves to trade crypto emotionally, they will incur significant losses.

While the term ‘Hodl,’ which is a misspelling of the word ‘hold,’ started as a joke, many investors, such as Elon Musk, swear by the tactic. For example, an individual who would have purchased one Bitcoin for $15,000 in 2017 using the buy and hold tactic would have 1 Bitcoin worth over $40,000 in 2022.

But to have this Bitcoin, they would have had to hold firm in 2018 when their investment crashed to $4,000. Professionals say this is challenging to do when buying cryptocurrency with no intention to keep it long term. Moreover, since crypto is still a relatively new and unpredictable market, it’s hard to say if buying and holding will remain the go-to strategy for investors.

Factors to Consider Before Adopting This Strategy 📜

By this point, the buy and hold strategy may sound like a pretty good investment style. But before an investor can implement it in a portfolio, there are several things an investor needs to consider. 

First, investors need to consider the time available. Remember, buying and holding will take some time to start up. So while it will be low maintenance later, the investor needs to have the time now to sit down and evaluate their options. 

The next thing to consider is capital on hand. Buy and hold investing ties up capital. If an investor cannot afford to have money tied up for at least a year, this long-term strategy is not ideal. 

Last, but not least, investors must take risk management into consideration. While buy and hold investing can be as simple as parking a large amount of money in a single company, this is not good for risk management. Instead, a buy-and-hold investor needs to take the time to either diversify their holdings or maybe plan to rebalance their portfolio. 

Once an investor has conducted their analysis and has capital available and a suitable risk management strategy in place, they can use this passive strategy to build their investment portfolio. 

Final Word: Is Buy and Hold A Good Strategy For You? 🏁

Overall, buy and hold is one of the most straightforward investment strategies on the market; after all, you only need to buy and hold! But, just as one shoe doesn’t fit everyone, there is a chance that buy and hold investing may not be the perfect strategy for you.

So take the time to review the information here and the time and capital you have available. Also, take the time to review the assets you want to buy and hold, ensuring the risk level is one you are prepared to handle. Finally, after evaluating these assets, you can decide if the buy and hold strategy is the right choice for your portfolio.

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