How does a Buy & Hold technique work?
Buying and holding stock is a more passive way to book long-term gains
Buy and hold investment technique is exactly what it says on the tin. Perhaps the most popular and easy-to-implement stock investment approach, it's one for the passive long-term investor rather than the day trader looking to book short-term profits.
The buy and hold technique appeals to those who are looking to hold stocks for a long period of time; many years or even decades, unconcerned about fluctuations in the market. The rationale is that in the long term, cash equities provide attractive returns despite short bouts of volatility.
This is based on the theory that during times of economic growth, rising interest rates and an uptick in the business cycle, you are likely to be more successful over a multi-year timeframe than rapidly buying into and selling out of positions throughout those periods of volatility.
Arguably, the sensible approach to the buy and hold strategy is the diversification of your investment portfolio to include more than stockholdings. It's never wise to put all of your 'eggs in one basket' so by including a mix of bonds and commodities for example, you're able to source more income-streams rather than just one.
The stocks held as part of this approach will depend on your personal investment strategy and style. Typically, stock selection requires extensive research into a company, its historical performance, financial results, growth prospects and valuation point. By employing this basic 'top-down' approach to stock-picking, you are more likely to ensure you are buying a stock with the greatest chance of growth potential and capital appreciation in the long term.
On a fundamental perspective, there's two types of stocks that warrant an inclusion in any buy and hold portfolio;
These tend to be companies with encouraging and ambitious earnings potential while paying out attractive dividends. Typically, a growth company would consistently report rising sales, solid profits and dominance in its market.
Value stocks are companies that have seen a decline in their share price to the point that they are considered 'undervalued', but the fundamentals of the company are compelling enough to suggest the underperformance is a short-term blip and there is growth potential in the foreseeable future.
The reason growth and value stocks are so important to your buy and hold strategy is that value stocks traditionally outperform growth stocks over the long term. That said, it's wiser to allocate both growth and value stocks to your portfolio as this diversifies the risk and may lead to smoother, higher overall returns over the term of your buy and hold technique.
- Easy to implement and minimal stress as the technique involves buying a stock and holding, which means you don't have to constantly monitor share prices or worry about short-term market fluctuations.
- Avoid the need to 'time the market' by predicting the changing cycle between bull and bear markets as buying and holding a stock eliminates the need to make time-based decisions.
- It is cost efficient as brokerage commission and fees are lower since the total number of transactions are minimal. That is not the case if you are buying and holding stock Contracts for Difference (CFDs), which triggers holding fees.
- Tax benefits are attractive since buying and holding stocks mean that with long term capital gains, you are taxed at a lower rate than short-term capital gains.
- Not knowing when to sell your stock, which can mean you hold onto it past the point where you're booking a loss on your investment.
- There's no limit to possible price losses since you avoid short-term market movements, leaving your stock vulnerable to economic or market downturns and profit warnings by the company which, over time, could prompt a loss from the position.
- Panic selling your stock during severe economic or market downturns could mean you remove it from your portfolio before it actually delivers you a return.
- Corporate bankruptcy by the stock you're holding can result to a complete write-down of your investment and a rebalance of your portfolio.
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