iFund- The Beauty and the Beast of Buy and Hold Strategy

2019-07-24 08:54
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Buy and Hold, sometimes also referred to as buy and forget, is always considered by many investors to be the Holy Grail of Investing.

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Buy and Hold, sometimes also referred to as buy and forget, is always considered by many investors to be the Holy Grail of Investing. It is simply and straightforward in which an investor buys an asset and holds it for long periods of time such as 10 to 40 years, because the investor believes that long-term returns can be reasonable despite short-term fluctuations and volatility in the market.

No better or no worse than the market

Investors can use buy and hold strategy on a single company, an actively managed fund or a bunch of securities, however, the
investment performance of this single investment/portfolio will depend on the research and selection capability of the investor. It runs the risks of underperforming the market considerably or it could become a totally loss investment if the investor does not have sufficient investing capability.  Therefore, a typical buy and hold strategy will always involve using other passive elements, such as dollar-cost averaging and low-cost ETF/index tracking funds on building a more diversified portfolio. This is especially true as most investors don’t have the foresight to predict which markets or assets are going to do
well in the future. As a result, the purpose of buy and hold for most people are not for beating the market over the long-term. It is actually a passive investing strategy that aligns with Efficient Market Hypothesis (EMH), which says that all known information is already factored into the current prices of the securities and there should be no amount of analysis that can outperform the market consistently. Another group of supporters for buy and hold are value-investing investors, who advocate that profits and corporate value would be maximized but with minimum risk on a long investment holding period.

Pros and Cons of Buy and Hold:

Pros:

    • Easy to implement. Build a diversified portfolio by simply invests in different low-cost ETFs or index tracking funds.
    • Efficient. Minimizes commissions and transaction costs, which could mean greater return for long-term.
    • Saves on taxes. For some investors (such as in U.S.), it enjoys lower tax rate from long-term capital gains and dividends vs. short-term capital gains.
    • Avoid market-timing.  Market timing is difficult and historical studies show market timing doesn’t work for most people. It removes the temptation to tinker through buying high and selling low.
    • Cons:

      Buy and hold implies prices and market analysis don’t matter. Given that the strategy requires you to buy and hold at all time regardless of price and valuation, it could underperform other strategies for a certain period of time, especially when you are entering into the strategy at extremely expensive valuation.

    • Ignores asset re-allocation. Asset allocation needs to adjust over times along with changes in risk appetite of investors. However, buy and hold does not allow for determining which investments should be hold over time. It implies risk is something to be accepted rather than controlled.
    • Ignores volatility. Volatility is not always a bad word. Buy and hold does not suggest to buy bargains stocks aggressively nor sell trendy overpriced investments, which many successful value investors do. Diversification is critical. A poorly constructed buy and hold portfolios can lose large gains very quickly and lead to underperformance.

To sum up, describing a buy and hold strategy is easier than to implement it in real life, especially it requires the investors to have strong psychological stance to tolerate large swing of markets. In the long run, a true buy and hold passive investor will most likely achieve average rates of return.

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