The buy-and-hold investing strategy explained
If you are trying to decide which investing strategy to use after having learned a bunch of new financial lingo, you might be thrilled to come across the buy-and-hold strategy. What you see is what you get! The buy-and-hold investing strategy is simple:
You purchase stocks and hold them for a long time, decades even, until you retire or even longer.
Phew. That was easy! Now, is it a good idea?
Warren Buffett does it. So how could it be wrong?
I believe in Warren Buffett. I'm the sort of fan who's read all the books and stood in line for hours to listen to him live (that's a good story for another time). It's really hard to argue with the third-richest man in the world, according to the Forbes 2012 World's Billionaires list. And Warren Buffett is a fanboy, too, of so-called "value investing"; the concept espoused by early investing great Benjamin Graham.
Value investing is almost just like buy-and-hold, but it's more of a focus on the stocks whose market prices (i.e. the value of the stock times the number of total shares) are less than their actual value, and hold them for years and years, or until the market price finally comes up to their real value.
This takes a lot of analysis, of course, which is supposedly what makes Warren Buffett so rich. But I'm tempted to believe it's not so much the careful monitoring of the value of the companies but the long-term, patient, unwavering holding that has made him rich. Sure, you've got to pick good ones to begin with. But when you're buying stocks with an eye toward holding them for decades, it's a lot easier to discard trendy companies or speculative, high-risk businesses.
'Buy and Hold' makes sense for everyone. Except…
I really believe in the buy-and-hold strategy, although there are certainly cases when one might want to get rid of a stock. Say, if it has gone bankrupt or the CFO has been indicted for accounting irregularities going back years (these are two examples of cases when I sold a stock; though, to be honest, in the second case I was too late to sell; the stock plummeted to $0 immediately). Or, if a company has done something you personally think is really stupid. Plenty of people sold tobacco stocks when they went before Congress insisting that their product was not addictive. But it's hard to find exceptions to the rule. Here are a few cases in which 'buy and hold' isn't a good strategy.
- If you're a professional investor with great access to information and lots of technical knowledge and experience. This would seem to be a great time to throw out the buy-and-hold strategy, except for data that professional money managers can't even beat the stock market index funds over time.
- If you don't have much money and want to own a diverse group of stocks. Well, in this case a stock market index fund might be a good choice for you. But it would still make lots of sense to buy the index fund and hold for a long time; knowing when to sell the fund (when the market was falling, theoretically) and rebuy (before it rebounded but JUST before) would be beating the market; and we just said that was near impossible!
- If your risk tolerance is extremely high and you were born to be a day trader. OK, sure, go crazy if you think you can't live any other way. I did have one friend (one!) in business school who made his entire business school tuition day trading during our second semester. He went on to be a Wall Street trader (of course). But even he told me he didn't think this was something he could replicate. It was just him taking advantage of that notoriously irrational exuberance resulting in a one-time success.
I can't really think of any legitimate reasons not to use the buy-and-hold investment strategy. Given that, and the famously successful examples of that strategy, I think, for a beginning investor, it's a great way to dip your toe into the stock market.
This Guide to Money answer includes the topics: Invest.