Long-term investors often buy stocks and bonds for their portfolios, and then hold these securities for years. While that’s a well-established strategy and one that can prove lucrative over time, does that mean it’s the best approach for every investor?
Many investment advisors and financial planners say a buy-and-hold strategy is more reliable over the long haul.
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“It’s very similar to driving on the highway: Driving at a consistent speed as long as possible is more likely to get you to your destination than accelerating, overtaking and swerving around traffic,” says Deva Panambur, a chartered financial analyst and certified financial planner at registered investment advisory firm Sarsi.
Drivers in a hurry may think speeding up and cutting ahead of others will get them to their destination faster. “But we know it does not work well over the long term, and the risk of not getting to your destination is quite significant,” says Panambur.
However, Panambur cautions that an investor’s portfolio must be resilient enough to perform well over time. “For most people, that would be a well-diversified portfolio of stocks and bonds, in a ratio that is appropriate for your risk profile, ability and willingness to take risks,” he says.
Here are some things to keep in mind when planning to implement a buy-and-hold strategy:
— The pitfalls of market timing.
— Risk management considerations.
— The importance of rebalancing.
— Avoiding emotional buying and selling.
— Capital gains pros and cons.
— Holding too long.
— Factoring in risk tolerance.
The Pitfalls of Market Timing
Attempting to time the stock market can result in costly mistakes, driven by emotional decision-making.
Market timing often fails due to the unpredictable nature of markets. It doesn’t help that it’s notoriously difficult for even professional investors to catch the market’s highs and lows at the proper times; this makes it extremely challenging to capture the expected returns.
“Typically, I see investors’ emotions wanting to take them out of the market, to avoid a decline,” says Brian Windsor, vice president and financial advisor at Bogart Wealth.
“The chances of getting the decision right and getting out prior to a decline are slim,” he says. “The even trickier part comes into play when you then must get back into the market. I have seen investors wait years, even decades on the sidelines. This leads to missed opportunity costs in the market and possibly missed long-term financial flexibility.”
Risk Management Considerations
With any investment strategy, risk management should be a key component. After all, if investors fail to safeguard their portfolios in favor of constantly swinging for the fences, they face the very real possibility of losing more money than they would with a more disciplined approach.
“Buy and hold allows for a diversified portfolio, which can help mitigate risk. It also avoids the transaction costs and taxes associated with frequent buying and selling,” says Michael Collins, founder and CEO at WinCap Financial.
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The Importance of Rebalancing
Some investors confuse “buy and hold” with “set and forget,” but that’s a mistake.
Rebalancing a long-term portfolio is an important step toward maintaining a predetermined desired asset allocation to both mitigate risk and capture opportunities. It also ensures alignment with investment objectives and often results in optimizing returns over time.
“Rebalancing may seem counterintuitive because it requires selling the outperforming investments in order to buy the underperforming investments for the sake of portfolio alignment,” says Maluwi Vodi, a financial educator at Financially Present in Centreville, Virginia.
“The bright side is that rebalancing is a good sign that there is some professional direction and discipline behind the managing of the portfolio,” he adds. “The downside is that it feels unnatural to people who aren’t familiar and can be met with resistance because it requires the investor to look at the bigger picture over time.”
Vodi says the process of rebalancing requires a little homework on the part of investors, who should revisit their risk profiles to be sure they are making adjustments that align with their long-term strategies.
Avoiding Emotional Buying and Selling
Buy-and-hold strategies reduce impulsive trading because investors focus on a long-term perspective rather than reacting to short-term market fluctuations.
“Buy and hold takes away the emotional aspect of investing, which can lead to rash decisions and potentially harmful consequences,” says Collins.
Capital Gains Pros and Cons
Capital gains can mean big profits over time for buy-and-hold investors, providing a source of income or reinvestment.
However, they also trigger tax liabilities upon realization, potentially reducing returns and requiring careful tax planning.
“Buy and hold can result in significant long-term capital gains, which are often taxed at a lower rate than short-term gains,” says Collins.
On the other hand, he adds, it may take longer for buy-and-hold investors to see returns, compared with using a more active trading strategy.
Holding Too Long
It’s certainly possible to hold an investment too long and see paper gains evaporate. In addition, as an asset class falls out of favor, long-term investors who don’t rebalance may see a large swath of their portfolios crater, dragging down total performance.
While holding an investment that’s performed well may seem to make sense, it’s not always to an account owner’s benefit.
“The all-too-familiar saying that ‘past performance does not guarantee future returns’ will haunt any investor who thinks a stock that is doing well now will always be a winner,” says Vodi.
“Investors are fond of holding flailing investments for sentimental value or a consistent dividend without reviewing the performance or suitability,” he adds.
Factoring in Risk Tolerance
Accounting for risk tolerance is crucial for buy-and-hold investors to make sure their portfolios reflect their ability to withstand market fluctuations.
“Buy and hold allows for a customizable approach based on an individual’s risk tolerance. It can be adjusted to fit different levels of risk tolerance and investment goals,” says Collins.
However, investing in a buy-and-hold strategy without considering risk tolerance can result in a mismatched portfolio that may not align with an individual’s goals.
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What Are the Pros and Cons of a Buy-and-Hold Strategy? originally appeared on usnews.com
