When I was 20, my uncle told me that one of the best ways to create a long-term fortune doing almost nothing is to invest in the stock market.
I didn’t believe him.
“Buy and hold for a long time and you’ll be fine,” he told me. “To really make money, you need to have a net worth. You will never get rich just by saving your paycheck.”
This conversation changed my relationship with money forever.
Despite the hype around trading these days, one of the best and most popular ways to build wealth in the long run is through the disciplined execution of a buy and hold investment strategy. If you’ve ever heard of Warren Buffett, John Bogle, or Peter Lynch, you know these ideals well.
However, if you are unfamiliar with the buy and hold investment strategy, I would like to share the wisdom my uncle passed on to me that has the potential to change your financial life as much as mine.
What does “buy and hold” mean?
A buy and hold investment strategy focuses on buying financial assets (stocks, ETFs) or real assets (real estate) with the intention of holding them for an extended period of time despite the ups and downs of the market or economy.
This is generally a more passive style of investing that excludes active trading, short selling, market timing, or any other activity that involves buying and selling assets within short periods of time.
Read more: How to Invest in Stocks: A Beginner’s Guide to the Stock Market
Pros of buying and holding
Since the “buy and hold” strategy has done wonders for Warren Buffett, you’re probably wondering why it has gained such a good reputation. In general, this is because the buy-and-hold approach tends to:
- Brings investors some peace of mind during market storms.
- Increases the chances of making money and not losing money.
Bringing calm in the storm
Because buying and holding is more passive than active trading, this allows investors to consistently invest in a set of investments they understand and believe in without worrying about short-term market fluctuations.
Since many of us may not have experienced periods of prolonged market volatility (until now), a buy and hold approach can allow investors to relax and forget about short-term market fluctuations (depending on time horizons, risk tolerance and risk potential).
Read more: Why You Shouldn’t Worry About the Stock Market Falling in a Recession
When the markets are volatile, it’s best to stay away from your portfolio. According to US Bank, those who entered and exited the market over time were much more likely to miss the best days of market performance, which significantly affected their profits.
If you had invested 10 X in the S&P 500 on January 1, 1990 and held it until December 31, 2021, your money would have increased by 26 X. Conversely, if you had missed the top 60 trading days during that period, you would have increased your money only 1.43 times.
Source: USBank.com | Screenshot by Aubrey Chapnik
Source: Giphy.com
This is the power of buy-and-hold investing. It saves you from yourself when it comes to panic selling.
The “buy and hold” approach also deters investors from the temptation to trade, since such activities rarely end well for most investors.
Read more: Are you at risk of depriving YOLO of your savings by trading too much?
Put the odds in your favor
A buy and hold strategy not only protects you from market ups and downs, but also increases your chances of making money and not losing it.
Given the power of compound interest – or what Albert Einstein called “the eighth wonder of the world” – the longer you’re in the market, the less likely you are to lose money.
Read more: If you still don’t believe in the power of compound interest, you should see this.
Between 1929 and May 2022, the investor had the following established probabilities of losing money on the S&P 500:
- 46% any day.
- 26% within 1 year.
- 6% over 10 years.
- 0% for over 20 years.
While past performance does not guarantee future returns, there is plenty of evidence to suggest that a buy and hold strategy is one of the most reliable ways to create wealth.
The same applies to those who invested at market peaks. The longer the buy-and-hold time horizon, the higher the chances of getting ahead.
Source: Ben Carlson, The Wealth of Common Sense | Screenshot by Aubrey Chapnik
Cons of buying and holding
While “buy and hold” sounds great, it has a few downsides:
- If you are not buying the market, it is difficult to know what to buy.
- When the market falls, it still hurts, and maybe for a while.
If you don’t buy the market, it’s hard to know what to buy
If you follow Warren Buffett, you know that in addition to being a buy-and-hold investor, he is also an expert in stock picking. Warren currently manages a portfolio of about 50 holdings (compared to 500 for the S&P 500) at Berkshire Hathaway, which owns his stock portfolio, and has built a significant lead over the S&P 500 over the past two decades.
With an average holding period of 20 years (compared to 5.5 months for other investors), Warren gained incredible experience in identifying the right stocks to buy and remaining confident in them.
Comparing Warren’s results to the stock picking study, which concludes that most stock picking companies don’t outperform the market and active traders end up far worse, it’s easy to see how dangerous it is to buy and hold individual stocks unless you’re Warren Buffett.
In fact, there are many market experts, such as Nick Maggiulli (recent author of Just Keep Buying), who have done extensive research and concluded that you shouldn’t even bother picking individual stocks.
Because there is little evidence that the average investor can implement a Warren Buffett-like strategy, buying and holding the market for long periods of time tends to provide the highest likelihood of success.
When the market goes down, it still hurts and maybe for a while
No matter what you invest in, corrections, bear markets and crashes are inevitable. In the event of an economic downturn, buy-and-hold investors could face periods of significant long-term losses if they choose not to sell their holdings.
As humans, we understandably have a hard time coping with such losses in the hope of a turning point.
All investors should be okay with taking on this investment risk, but holders especially should be buying. When the market is down and you see red, it’s nice to sell. In my own experience trading single stocks, I know the feeling all too well.
But, according to Charlie Munger (an associate of Warren Buffett), “if you are going to invest in stocks for the long term or in real estate, of course there will be periods when there is a lot of agony, and other periods when there is a boom. You just have to learn to live through them.”
Read more: How to determine your investment risk tolerance
bottom line
When you look at the data, it’s clear that a buy and hold investment strategy is a great way to build wealth in the long run if done right.
If you really have the urge to actively trade or pick stocks, consider setting aside a small chunk of your portfolio as “fun” money and getting it.
We all need to leave room for fun, right?
Featured Image: PX Media/Shutterstock.com
