How do you think value investor Warren Buffett reached such great heights in his financial success? He was very particular in his investment selection and never allowed himself to buy and sell in a short period.
One of the great secrets to Buffett’s success was simple: implementing a buy-and-hold strategy. In fact, nearly 94% of his wealth came after he turned 60 years old.
This article will help you understand how the buy-and-hold strategy works, which type of investments you can use for long-term success, and the upsides and downsides of the buy-and-hold approach.
What Is the Buy-and-Hold Strategy?
Buy-and-hold is an investment strategy where you own stocks, ETFs, or any investment for a long period of time, typically five years or more. If you opt into this strategy, you actively select investments but have no intention of profiting from short-term price movements.
Compared to active investing, which aims to beat the stock market’s average return by taking advantage of price fluctuations, the buy-and-hold strategy is a passive investment strategy. This means buy-and-hold investors would rather stay in the market than beat the market.
High Returns and the Buy-and-Hold Strategy
If you hold stock in a company for five years or more, you are more likely to realize consistent high returns than other investments despite volatility in the markets. The reason for the higher returns is because the market goes up more often than down, and compounding those returns during good times yields a higher overall return.
Let’s look at a buy-and-hold example to show how great returns would be over a long period. Tesla’s (NASDAQ:TSLA) debut was in June 2010 at an IPO price of $17. Let’s say you bought 300 shares of TSLA at this price and held the stock until January 8, 2021, when the stock price was at $868. You would have profited $255,300. That’s a 5,006% return in almost 11 years!
Despite the volatile bear markets since 2010, such as the market crash of 2020 when the S&P 500 dropped 34%, investors who held onto Tesla during difficult times still came out on top with major gains. The market rewards those who stay in even when market downturns occur, which can further help your retirement nest egg.
Using the Buy-and-Hold Strategy in Real Estate
This strategy does not just pertain to the stock market. If you want to diversify your investment portfolio’s asset allocation, real estate is a smart option for buy-and-hold investing.
Purchasing rental property can yield long-term benefits by offering rental income. If you buy and hold real estate, you can also bring in consistent cash flow, which creates an income stream that easily adds to your retirement cushion.
Like a buy-and-hold strategy in the stock market, buying and holding real estate can help protect you in the event of housing market downturns and price fluctuations. Also, real estate’s low correlation to the stock market means you can fare well during times of overall volatility.
Just like in the stock market, you can use either active or passive investing in real estate. Flipping a property is an active strategy where you are looking to make a quick profit. You work for the asset instead of letting the asset work for you.
When you use passive investing, like a real estate buy-and-hold strategy, you take advantage of appreciation, which is the increase in property value over a long period. Also, come tax season, you can write off depreciation, mortgage interest, and loan fees.
What if you don’t have the capital to buy and hold real estate? That’s fine because REITs can provide diversified exposure in your portfolio and are great as a long-term investment.
Benefits of the Buy-and-Hold Strategy
Buying and holding has many benefits. Let’s look at the two most prominent upsides to this strategy.
Capital Gains Tax
A considerable benefit of a buy-and-hold strategy is the long-term capital gains tax. When you hold an asset for a year or more, the tax you pay on the asset’s sale is in your favor. If you were to sell an asset in less than a year, you are subject to the short-term capital gains rate, which is the same as your income tax rate and higher than the long-term capital gains rate.
For example, let’s say you make $100,000 a year, and your tax filing status is married filing jointly. Based on 2021 tax tables, your long-term capital gains tax rate would be 15%, and your short-term capital gains tax rate would be 24%.
You bought 100 shares of XYZ stock at $30 per share and sold them at $80 per share. Come tax season, you would only pay $750 of your profit if you held it for over a year. However, if you had held the stock for a shorter period of time, your gain would be taxed at your ordinary income tax rate, so in total you would pay $1,200 at the short-term rate.
Elimination of Timing
Market timing usually works against your investment decisions because some investors try to predict when a bear market hits. But this strategy eliminates the likelihood of making a string of poor timing decisions by holding and riding out the wave of market downturns.
Drawbacks of the Buy-and-Hold Strategy
Despite the benefits of this strategy, you still want to be cautious, as you would with any type of investing. You need to know your risk tolerance and be prepared for potential losses.
Your risk tolerance determines how much risk, or losses, you can withstand in your investments. If the stock market drops considerably, can you withstand losses, or do you panic and sell at the worst possible time out of worry? Selling all of your shares due to fear and panic means missing out on long-term capital gains in the future.
Loss of Principal
When buying and holding stocks, ETFs, or mutual funds, you believe those investments will grow in value over time. However, a stock’s price can tank after you invest — perhaps due to bankruptcy or a financial crisis — and may not recover in value. If that happens, you’ll lose your entire initial investment.
Buy Now and Be Patient
Whether you want to invest in stocks, ETFs, or real estate, a buy-and-hold strategy can not only help build wealth for the golden years but also create wealth for your family. Remember, there are downsides to every strategy when investing. Be mindful of your risk tolerance to make the best decisions for your situation.
If you’re ready to use the extra cash you have lying around to buy and hold companies for the long haul, we can help you identify stocks that can be the backbone of your retirement.
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