Buy and Hold Investing
Getting rich the slow way.
Like many people, I’m sure you’ve heard stories about the guy who invested in the stock market on a “hot tip” from his cousin’s neighbor’s gardener, and made millions overnight. I’m not going to tell you that this never happens, but you have a better chance of winning the lottery – while being hit by lightning. The reality of it, and what you never seem to hear, is that for every one of these potential lightning struck lottery winners, millions of people lose billions of dollars taking a chance on a “hot tip”. If you invest in the stock market with the idea that you want to get rich quick, you might as well just gamble your money away.
There is a way to make money in the stock market and it isn’t a get rich quick scheme. It’s a simple, long-term strategy known as “buy and hold” investing, and has worked for many as a highly effective way of building a nest egg for the future.
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You’ll never win by timing the market. To succeed, you need to be in the market.
“Buy and hold” investing is a passive investment strategy where you buy stocks and hold them for a long period of time regardless of fluctuations in the market. Many investors choose this method because of its simplicity.
If you look at the stock market since its inception, you’ll see that it is valued higher now that it was back then. Sure, there have been some set backs, some years with slow or no growth and some years where it has lost value, but over the long term, it has increased, risen to new highs. The “secret” is to wait out these slow stretches for the stock market to rise again.
Some investors try to time the market by anticipating the markets’ movements and trading based on what they feel the market or the economy will do. While this may seem practical and profitable, locking in the exact highs and lows is a difficult thing to do – even for investment professionals.
The stock market, over the short term, is volatile by nature and an investor who tries to time the market or who exits when he sees his stock dropping more then likely will miss out on the larger potential growth inherent in the market. An investor using the “buy and hold” strategy can take advantage of the market’s overall growth trend to make money.
It isn’t rocket science.
You don’t need a PhD, you don’t need to quit your job and sit in front of a terminal all day, and you don’t even need to have a lot of money to start. Anyone can start investing using this approach with a minimum of time and money. It’s as simple as consistently investing small amounts into companies that you already know.
Invest in what you know.
There are plenty of solid, stable companies whose products we come in contact with every day. You use a certain brand of soap or shampoo; you have a favorite brand of cola; or even a restaurant you frequent. You trust these companies enough to use their products, why not invest in them as well?
Making a mountain out of a molehill
You don’t need to start with a fortune to start investing; you can do it by setting aside a small amount each month. Through the magic of time, these small amounts invested consistently will grow into your fortune. Even as little as $5 or $10 a month can eventually grow into thousands and even millions.
According to a University of Michigan study, the average annual return for the U.S. Stock Market for the 30 years from 1963-1993 is 11.8%. For our example, we’ll us a more conservative 6%.
If you invest $100.00 today at 6%, you will have $106.00 in one year ($100.00 x 1.06). Now let’s say that rather than withdraw the $6.00 gained, you keep it in there for another year. If you continue to earn the same rate of 6%, your investment will grow to $112.36 ($106.00 x 1.06) by the end of the second year. Because you re-invested that $6.00, it works together with the original investment, earning you $6.36, which is $0.36 more than the previous year. This little bit extra may seem like peanuts now, but let’s not forget that you didn’t have to lift a finger to earn that $0.36. More importantly, this $0.36 will also grow. After the next year, your investment will be worth $119.10 ($112.36 x 1.06). This time you earned $6.74, which is $0.74 more than the first year. This increase in the growth each year is compounding in action. If this process is allowed to continue, the income begins to grow exponentially.
In addition to Compounding, other topics such as DRPs (Dividend Reinvestment Plans), Diversification, and Dollar-Cost Averaging, can help maximize your investments and we’ll talk more about those another time.
But hold for how long?
The key to using this method is patience. It may take several years for some stocks to show real gains.
A good starting point is ten years. If you don’t have that much time, the “buy and hold” method can be risky. If you plan on retiring next year, then this probably isn’t the strategy for you. If you buy a stock for a child at a young age and hold onto it until he or she goes to college, you may find you have more than enough money for college expenses.
Many “buy and hold” investors usually set specific goals for their investments and only sell when they have reached these goals. A goal can be as simple as setting a number of years or making enough money for retirement, a college fund, or a house.
Other advantages of “buy and hold”.
One advantage of “buy and hold” investing is that you save money on transaction fees (commissions, exchange fees, taxes, etc.). Consider an active trader – one who makes upwards of 5 trades a day – he may make over 150 trades in a month versus a buy and hold trader that may make one or two. That’s a big difference, even if you only pay $5 per trade.
Another big advantage of holding your stocks longer is that you pay less in taxes. By holding your stocks for at least a year, you pay the reduced capital gains tax rate of 15% vs. 28% for stocks held less then one year. Plus you only pay taxes when you actually sell the stock, so if you hold a stock for 15 years you only pay capital gains taxes on the 15th year.
Where to go from here …
A more refined version of this strategy is called Value Investing – and there have been many books written about it. A search on “value investing” will turn up quite a few, but if you’re interested in one of the best, look up The Intelligent Investor
A call to action
“Buy and hold” investing is simply a disciplined method of investing, which can help you avoid several common investing mistakes and insulate you from the short-term fluctuations of the market. As a buy and hold investor you will not be subjected to the costs of frequent trading, the risks of market timing or the expenses of the higher capital gains taxes. So what are you waiting for? There’s no better time then right now to start investing in your future.