The Rationale of Buying-and-Holding

The buy-and-hold technique is a passive investment strategy based on the premise that over long periods of time, the returns from common stocks will exceed the returns earned from other investments. It also stems from the fact that stock markets have historically always increased in value. The object of a buy-and-hold strategy is to do as well as the market. There is absolutely no attempt made to beat the market's performance. By compiling a broadly diversified portfolio, the investor should be able to approximate the performance of the market. Stocks in the portfolio are selected and held for the long term. Once assembled, there are very few changes made to the portfolio, and no attempts are made at market-timing. Therefore, the success of this type of investment strategy is largely dependent upon the condition of the market as a whole.

During a bull (or upward trending) market, a buy-and-hold strategy will benefit most investors. Of course, during a market correction or crash, the prices of most stocks will also decline. However, the stock markets have historically bounced back after nearly every downturn, recovering their losses and even gaining more. The buy-and-hold strategy rests upon this anticipated behavior.

Buying-and-holding circumvents the need to time the markets or read the financial pages on a daily basis. With a long-term investing horizon, there's no requirement to time the markets because the investor is not seeking to get in or out; the position remains fully invested in the portfolio's stocks.

Another benefit of the buy-and-hold strategy is the fact that transaction costs are minimized. Additionally, the expense of acquiring information is also greatly reduced. Of course, this shouldn't be construed to mean that the stocks are purchased and then simply ignored or forgotten about. Regardless of the investment strategy employed, all investors should periodically review the performance of their stocks with regard to growth in sales and profits, and replace those securities that don't exhibit future growth and earnings potential.

Although the buy-and-hold strategy minimizes the timing decisions of when to purchase and when to sell, the investor is still faced with the dilemma of deciding which stocks to select. Using a market index, such as the Standard & Poor's 500 or the Dow Jones Industrial Average, the types of stocks to choose becomes a much easier process. By choosing the same stocks in a particular index for his or her portfolio, the investor can replicate the performance of that market index.

However, it could be somewhat difficult for an individual investor to duplicate these indexes because of the large numbers of stocks that they contain and, hence, the enormous dollar cost that would be entailed. Index mutual funds can therefore be used, making it much more practical to invest in all the stocks of a specific index. Which index to follow, then, would depend upon the investor's overall objectives. A conservative investor looking for income and capital preservation would likely consider blue chip- or utility stocks, or some of the more established growth stocks. A more aggressive investor might seek growth stocks and perhaps the stocks of small-capitalized companies.

blog comments powered by Disqus
Scottrade