In general, to make money off of the stock market, you can either invest with speed and risk or with steadiness and safety. Although many investors use the first approach, more of them prefer the second one. These buy-and-hold investors try to find undervalued stocks and buy them to hold on to them until the market realizes their true value.
If you are planning to use this approach, you need to learn the following pros and cons inherent to this strategy.
Pros
It’s Effective
It’s actually a very effective strategy. Throughout the years, investors have seen exponential returns on their invested capital.
As a matter of fact, top investors in the world are also reputable buy-and-hold practitioners. These investors include Warren Buffett, John Templeton, Peter Lynch, Jack Bogle, and Benjamin Graham.
Fewer Worries
Sometimes, learning and applying technical analysis in actual investing is a pain in the head. Other times, investors really just don’t buy into the practice.
Many long-term investors and academics argue against technical analysis, claiming that “timing the market” is an inefficient practice, not to mention the market is riddled with anomalies.
So, if you would rather use buy-and-hold strategy, you can leave technical analysis behind. You can instead look at the overall characteristics of the market, the stock, and the outlook for future growth.
Based on Facts
The buy-and-hold strategy is almost entirely fundamental analysis. This type of analysis is based on facts, leaving very little work for guesswork.
You deal with hard facts that come from income statements, cash flow statements, and balance sheet. And you can never go wrong (often) with facts.
Tax Benefits
Lastly, tax benefits are great for long-term capital gains. Any investment that you hold and sold for a period longer than a year is eligible to be taxed at a more favorable rate.
Cons
Long-Term Capital Commitment
The biggest downside to the buy-and-hold approach is that there’s large opportunity cost linked to it. To adopt this approach means you have to be tied up to the stock for a long term.
That means you should have tough discipline to not chase after other investment opportunities during the holding period.
Time Investment
At the same time, the strategy is time-intensive. Holding on to the asset for a decade doesn’t guarantee equivalent returns. For instance, look at how slow utility stocks have grown over the years and compare it to how fast biotech companies boomed.
You can try to mitigate these downsides by diversification or buying and holding an index fund. However, the performance of your portfolio based on some good stocks can be weighed down by the laggards.
Market Crash
Also, even if you choose to buy and hold a whole index, it doesn’t necessarily mean that you’re immune to market crashes.
You may see your profits grow over time and decide to hold it a little longer, not knowing a market crash is just around the corner. And when it happens, you will only think of blaming yourself for not cashing in on those investments earlier.
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