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What is a buy-and-hold investment strategy?

What is a buy-and-hold investment strategy?

When I was 20, my uncle told me one of the best ways to build long-term wealth by doing almost nothin

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When I was 20, my uncle told me one of the best ways to build long-term wealth by doing almost nothing was to invest in the stock market.

I did not believe him.

“Buy and hold for the long term and you will do well,” he told me. “To really make money, you have to own equity. You will never get rich by just saving your salary. ā€

That conversation changed the way I think about money forever.

Despite the hype surrounding trading these days, one of the best and most popular ways to build long-term wealth is by pursuing a buy-and-hold investment strategy with discipline. If you’ve ever heard of Warren Buffett, John Bogle, or Peter Lynch, you know this ideal.

However, if a buy-and-hold investment strategy is unfamiliar to you, I would love to share the wisdom that my uncle passed on to me, which could potentially change your financial life as much as it changed mine.

What does “buy and hold” mean?

A buy-and-hold investment strategy focuses on buying financial (equities, ETFs) or real assets (real estate) with the aim of holding them for long periods of time, despite the ups and downs of the market or economy.

This is typically a more passive style of investing that relinquishes active trading, shorting, market timing or any other activity that involves buying and selling assets over short periods of time.

Read more: How to invest in stocks: the beginner’s guide to the stock market

The benefits of buying and holding

Since the buy-and-hold strategy did wonders for Warren Buffett, you’re probably wondering why it gained such a good reputation. In general, this is because a buy-and-hold approach tends to:

  • Bring investors some calm in market storms.
  • Increase the chance of making money and not losing money.

Bring calm to a storm

Because buying and holding are more passive than active trading, it enables investors to consistently put money into a set of investments in which they understand and believe without worrying about short-term fluctuations in the market.

Since many of us may not have experienced periods of extensive market volatility (until perhaps now), the buy-and-hold approach can make investors sit back and forget about the market’s short-term circulations (depending on time horizons, risk tolerance, and risk capacity). .

Read more: Why not worry about a stock market downturn when a recession hits

When markets are volatile, it’s a good thing to be more hands-off with your portfolio. According to US Bank, those who jumped into and out of the market over time had a much greater likelihood of missing out on the best days of market performance, which ate up significantly in their returns.

If you had invested $ 10X in the S&P 500 on January 1, 1990 and held it until December 31, 2021, you would have valued your money 26X. Conversely, if you missed the best 60 trading days during that period, you’re only 1.43X’ed your money.

Source: USBank.com | Screenshot by Aubrey Chapnick

Source: Giphy.com

This is the power of buy-and-hold investment. It saves you from yourself when it comes to panic sales.

The buy-and-hold approach also frees investors from the temptation to trade, as these types of activities rarely end well for most investors.

Read more: Are you running the risk of YOLOing away your savings by trading too much?

To place the odds in your favor

In addition to protecting you from market ups and downs, a buy-and-hold strategy increases your chances of making money and not losing money.

Given the power of composition – or what Albert Einstein calls the “eight wonders of the world” – the longer you are in the market, the less likely you are to lose money.

Read more: If you still do not believe in the power of compound interest, you need to see it

Between 1929 and May 2022, an investor had the following established probabilities of losing money in the S&P 500:

  • 46% any given day.
  • 26% over 1 year.
  • 6% over 10 years.
  • 0% over 20 years.

Although past performance does not guarantee future returns, there is ample data to suggest that a buy-and-hold strategy is one of the most reliable ways to build wealth.

The same goes for those who have invested in market peaks. The longer the buy-and-hold time horizon, the better the chance of getting ahead.

Source: Ben Carlson, “A Wealth of Common Sense” | Screenshot by Aubrey Chapnick

The disadvantages of buying and holding

Although buying and holding sounds great, it has some drawbacks:

  • If you are not buying the market, it is difficult to know what to buy.
  • When the market falls, it still hurts, and can for a while.

If you do not buy the market, it is difficult to know what to buy

If you follow Warren Buffett, you know that in addition to being a buy-and-hold investor, he is also an expert stock picker. Warren currently manages a portfolio of ~ 50 interests (compared to the 500 of the S&P 500) with the company holding its equity portfolio, Berkshire Hathaway, holding a strong record to beat the S&P 500 over the past two decades.

With an average holding period of 20 years (versus 5.5 months for other investors), Warren has developed incredible expertise in identifying the right stocks to buy and retaining conviction in them.

By comparing Warren’s results with research on stock selection, which concludes that most stock voters do not outperform the market and active traders end up much worse, it is easy to see how buying and holding individual stocks can be dangerous. be if you are not Warren Buffett.

In fact, there are many market experts out there like Nick Maggiulli (recent author of “Just Keep Buying”) who have done substantial research to conclude that you should not even bother to choose individual stocks.

Since there is little data to support that the average investor can execute a Warren Buffett-like strategy, buying and holding the market over long periods of time tends to offer the highest probability of success.

When the market falls, it still hurts and can hurt for a while

No matter what you invest in, corrections, bear markets and collapses are inevitable. In the event of a downturn, buy-and-hold investors may experience periods of significant long losses if they choose not to sell their holdings.

As humans, we understandably have trouble dealing with these types of losses in hopes of a turnaround.

All investors should be ready to accept this risk of investment, but buying and holding should especially. When the market is down and you see red, it feels good to sell. From my own experience trading individual stocks, I know this feeling too well.

But in the words of Charlie Munger (Warren Buffett’s partner), ā€œIf you are going to invest in stocks for the long term or real estate, there will of course be times when there is a lot of pain and other times when there is a boom. You just have to learn to live by them. ā€

Read more: How to determine your investment risk tolerance

The bottom line

If you look at the data, it’s clear to see that a buy-and-hold investment strategy is a great way to build long-term wealth – if done right.

However, if you have an active trading or stock gimmick, consider allocating a small piece of portfolio as “fun” money and keep at it.

We all need to leave some space for fun, right?

Exhibition image: PX Media / Shutterstock.com

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