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Why Buy and Hold Stock Strategy is Good for Long-Term Investment

By: , dated January 25th, 2013

“Buy and hold” doesn’t exactly sound like some brilliant investment strategy let alone like any path you want to take where investing your hard earned money is concerned. But, historical data tells us that the buy and hold strategy works with equities – given a long enough timeline. Long-term investment strategies tend to look ahead in decades and the buy and hold approach works with stocks as long as you have a decade or two to play with. If not, market fluctuations including the appearance of bears, inflation, and overall downturns will cause many to dump their stocks within the first 2-5 years.

When you actually implement a true and effective buy and hold strategy with your stocks then there can be, will be, and even should be periods of time when you are losing money in a fiscal year. Yet, when the long haul is a path you can comfortably take with your finances, then the buy and hold approach will almost surely net you around 10% a year on the initial investment with minimal, if not acceptable, risk. Of course, this is with a typical “buy and hold” portfolio, such as those created by insurance companies or pension funds.

Traditional “Buy and Hold” Portfolio

A mutual fund is a typical investment tool used by pension funds, insurance companies, and ordinary investors to help build wealth while minimizing risk. A typical mutual fund will decrease risk by diversifying the portfolio between bonds and equities (stocks). Naturally, the rate of return on any mutual fund over a period of time will depend upon its composition, or how the funds are allocated. The specific needs and financial position of the investor must be taken into account when choosing a mutual fund. However, the “traditional” buy and hold portfolio would typically include 60 percent of stocks and 40 percent of bonds – or a 60/40 portfolio.

Again, the actual mutual fund to choose and its corresponding asset allocation will depend upon the needs and situation of the investor. Where long-term investment growth is concerned with minimal risk, the 60/40 is a standard mutual fund option for an investor that has proven itself over the decades. The stocks in this traditional buy and hold portfolio will fuel growth and lead to potential capital gains in the future. If the stocks payout dividends, then there is a steady revenue stream too in addition to the (hopefully) appreciation of the basic amount invested.

The bonds in a traditional portfolio provide a reliable revenue stream that can be used to supplement income. This brings a sense of stability to the portfolio as bonds tend to have far less risk and they provide a stream of income in the form of interest payments. Of course, the revenue generated can be predicted accurately and is therefore limited and will not provide the sort of growth opportunities that stocks can provide. Younger investors will probably be better off with a portfolio featuring more stocks and greater growth opportunities. Older investors nearing or already in retirement will probably prefer portfolios with a greater percentage of bonds and their more reliable revenue streams and a lower proportion of stocks and their associated risks. Therefore, the traditional 60/40 buy and hold stock strategy may yield an average of 10 percent per year over a long enough timeline, but it may not be the correct proportion for you or your financial needs.

The best way to maximize your long term investment returns is to optimize your buy and hold stock strategy. While the particular percentage of equities and bonds in your portfolio will vary according to factors relating to age and financial situation, the composition of those stocks also needs to be looked at carefully in order to get the largest returns on your money. To do this, you will need to understand the difference between growth and value stocks.

Growth Stocks

When you think about growth stocks, think about younger companies that have carved out a significant market position and are poised to make even bigger gains in the future: Google and Apple are both good examples of growth stocks. Basically, companies that have rising sales, solid profits, and a dominance of some kind in their markets. Generally, companies that rank high on the S&P 500 Index would be considered growth stocks.

Value Stocks

Value stocks are essentially what their name implies: a value for money. Essentially, value stocks are so because the associated companies aren’t doing well now but they are in a good position to do much better in the foreseeable future. Therefore, their stock prices are actually low but a spurt of tremendous growth is very possible which could cause spikes in share prices in the not-so-distant future.

There are a number of reasons that could be causing poor performance in the present time period. Poor management is a common problem that causes poor performance but can be readily fixed in a number of cases. New competition is another factor that can result in a short term loss of market share and profitability but may very well not be an issue a year or two from now. Some value stocks that have posted major turnarounds in recent years are Coca-Cola and Hewlett-Packard.

The reason why growth and value stocks are so important to your buy and hold strategy is that value stocks traditionally outperform growth stocks – over the long haul. While it would not be advisable to place of all your stock investments into value stocks, it would be wise to split the allotment. Therefore, invest half of your money into growth and the other half into value stocks. In the long run, this should lead to a higher overall average return while not significantly increasing your risks.

The buy and hold stock strategy is nothing new in the world of finance. Nor is it a radical concept to differentiate between value and growth stocks and realize that value stocks can be purchased at a bargain and sold for a mint if you find and buy them at the right time. However, there is naturally a greater risk when buying value stocks. After all, the company’s stock prices may never rise again and the current prices may actually be overvalued given the condition of the business. However, by balancing your stock investments between both growth and value stocks, there is definitely a greater potential for growth than in a portfolio featuring only growth equities. The buy and hold strategy will work given a long enough timeline, but it will work even better when you take the time to modify it to your particular needs and diversify it properly.

This article was brought to you by the InvestorGuide Staff Writers and Editors.

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