Pros and Cons of Buy and Hold Strategy
Every investment strategy has its risk, and a passive “buy and hold” is no exception. Here are some of the positives and negatives throughout the process.
Nearly every financial expert agrees that real estate and the stock market are the best ways to invest your money. And they’re more alike than you might think.
When you’re aggressively trading stocks, you want to find ways to reduce transaction costs like trade commission, and when you’re buying a house, you want to save on realtor commission. And just like a trader wants to find a low-priced stock that has plenty of room to grow, entire real estate empires have been built by buying houses for cash, renovating them, and selling them high.
But playing the stock market takes more strategizing than buying real estate. After all, you can buy and sell a stock in the same day — it’s a much more fluid, fast-moving market.
Generally speaking, there are two kinds of stock traders. The first one believes they have a special insight into the market or a unique trading strategy that gives them an edge. They execute a lot of trades rapidly to take advantage of market fluctuations, and they aren’t afraid of unconventional investments.
The second kind of trader believes there are no secrets, and that everything important about a stock has already been priced in. When they find a stock they believe offers solid value, they buy it and hold onto it — for years, or even decades — and have faith that the market will carry them to the promised land.
This type of strategy is called the “buy and hold” strategy, and if properly used, it can be extremely lucrative.
For example, if you’d figured out in 2002 that caffeinated energy drinks were going to explode in popularity, and put your money into Monster Energy stock, your investment would’ve grown 87,560% over the past two decades.
Still, every investment strategy has its pros and cons, and “buy and hold” is no exception. Let’s look at some of the positives and negatives of buying and holding.
Simplicity is one of the highest virtues, and “buy and hold” is elegantly simple. You simply find value, buy in, and let the market deliver profits. Unlike active traders, who are forced to monitor the market hour to hour or even minute to minute, you can check in on your investments once a month or less.
It’s Based on Solid Analysis
Before you buy and hold, you’ll want to research your prospective investment to make sure it’s a good long-term prospect. If your analysis is solid, your investment will be solid. And when you do eventually buy in, you can do so with confidence — and weather the ensuing ups and downs without having second thoughts.
Short-term trading is often less logical. It can be more reactive to market movements and can sometimes resemble gambling.
It Puts You in a Good Tax Situation
Profit from an investment held for less than a year is subject to short-term capital gains tax, while profits from investments held for longer than a year are treated as long-term capital gains. The good news for buy-and-holders? Long-term capital gains are taxed at a more favorable rate than short term capital gains.
It Saves You Money
Trading comes with transaction costs, and the more trades you execute every day, the more those costs add up. If you buy and hold, though, you don’t have to worry about costs like trade commissions eating into your profits.
It’s Less Risky
The term “manager risk” basically describes the risk of human error that’s introduced when you’re actively trading and managing your portfolio. The more trades you execute, the more risk you’ll make a bad decision and cost yourself money.
Buy and hold minimizes manager risk almost down to zero.
Your Money is Tied Up
The money you invest in those long-term stocks is going to be tied up for the duration of your investment, which could take several years.
If another investment opportunity comes along, you won’t be able to take advantage. If an emergency comes up, and you need to sell off, your long-term gains are now lost.
You Could Miss Out
When the market is volatile, as in the post-2008 bear market, there’s a lot of money to be made by active trading. If your money’s tied up in your “buy and hold” stocks, you may be stuck on the sideline, watching your more aggressive competitors cash in.
You’re Vulnerable to a Correction
Corrections happen every decade or so, which means that the longer you hold onto your investments, the more likely it is you could be stuck in a crash. Of course, no one knows when it’s coming. You can always find analysts swearing the market will never crash again, but it’s a real risk.
There’s Still Risk
Investing is always a risk, and there’s no guarantee your investments will appreciate along with the overall market. Buy-and-hold seems like a very safe investment strategy, and it can definitely be safer than active trading, since you’re avoiding all the variables introduced by frequent buying and selling, and relying on your expert analysis to guide your investments.
Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers, and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the L.A. Times, and more.