Macroeconomic news, such as a tick up in inflation, can send shockwaves throughout the market, causing a sell off. On that same note, something as small as ‘a research note about a specific stock could spur investors to sell.
However, in either of these cases, the panic and subsequent want to sell should not be the rule of thumb. If your knee jerk reaction to anything that pressures your investment is to sell, you should weigh the benefits of buy-and-hold strategies.
Here, we’ll note some of the things to keep in mind about this type of strategy, including how they can help you grow the holdings in your portfolio over the long term.
Buy and hold defined
As the phrase indicates, buy-and-hold strategies entail buying a security and holding it, preferably until your financial goal is met. That means you’ll hold it no matter how low its value may go. The strategies can be used for any asset class, including stocks, bonds, and even real estate.
Often, buy-and-hold strategies are called “the Warren Buffet Way”, which is also the name of a book that details how the value strategy was practiced by the billionaire to build his wealth. The passive investment strategy generally means that the investor never sells a holding because the value or price of the investment tanks.
Determining if buy-and-hold is right for you
Many things seem to be good in theory, but once they are put into practice, that can change. Such is the case for the buy-and-hold strategy. If your risk tolerance makes you prone to want to get out of your position as soon as you see the investment’s price falling, buy-and-hold may be difficult for you to stick to.
The first step in determining if the buy-and-hold strategy is right for you is to evaluate your long-term goals. These goals can include retiring, or saving up enough to cover your child’s, or children’s, college education. Over the course of meeting these goals, typically 10 to 20 years or more, depending on when you start investing, you’ll have time to recoup any losses.
Once you’ve done this evaluation, determine if you can afford to invest over the long term. This means making sure you won’t need the money in the meantime, such as for a down payment on a house.
All systems go
If you decide that you have the risk tolerance, discipline, and money, to stow away in investments for the long haul, you can better build your portfolio.
This is where asset allocation and diversity come into play. You should include a mix of assets from various sectors. Considering that the prices of asset classes, and their respective sectors, usually rise and fall in tandem, the portfolio’s total return can be more affected by its allocations than by the specific securities it holds, Investors Answers points out.
In building your portfolio with a buy-and-hold strategy, you should also consider including index funds. An interesting point to remember is that the buy-and-hold strategy does not guarantee you a huge payout for holding on to your investment. If poor picks are made, however, they can be mitigated through buying and holding an index fund.
“..the performance of a portfolio based around a few high fliers can be dragged down by the laggards. Moreover, there is nothing stopping an investor from mistakenly picking and holding an entire portfolio of duds. For the latter point, index funds have also proven to not be immune to certain events, such as crashes.” – Investopedia
Determining what to buy and hold
Although buy-and-hold strategies do not rely on any specific time frame, most stretch for three to five years.
As you keep that in mind, there are some other factors to keep in mind in using this strategy.
One relates to the stock’s fundamentals. Evaluate them to help determine if it is worth holding for a long period of time. Look at the company’s earnings per share to learn its P/E, or price-to-earnings ratio. Also, look at its book value, which shows whether it is expensive or cheap compared to other stocks in its sector.
Cash flow is also a great fundamental to take into consideration because it reflects a company’s financial health.
If you pay attention to the options markets at all, they can provide you with a sense of where other investors and traders stand on a stock. For example. If there is a considerable amount of open interest in put contracts, investors think the stock will fall at some point. The expiration dates of these contracts can show you how far out investors’ pessimism may go.
If you see where there is considerable put activity, or even a high, short interest (20% or above) in a stock, it may not be worthy of a buy-and-long strategy.
Investors looking for fast and hefty returns often frown on buy-and-hold strategies because, by their nature, are passive. The thought of not getting out of a position ahead of the possibility of their investment losing them money causes considerable angst.
The short-sightedness can lead to one of the worst things investors can do: sell on the dip.
Look no further than the 2016 Presidential election. Markets around the world sold off significantly as panic about the new administration set in. Within 24 hours, these markets not only rebounded, but soared to record highs.
The investors who did not sell their holdings fared well, as their portfolios, although initially jolted, began seeing favorable returns within months of that election.
Determining your investment goals, and staying focused, are key to the success of your buy-and-hold strategy use. History is on the side of the investors who practice it. Just look at Warren Buffet!