There are many investment strategies you can use in the financial market. We look at the buy and hold strategy and how you can use it to invest. In this article, we will look at the buy and hold strategy and whether it is a good investment strategy for investors.
How to profit from the finance industry
The finance industry is one of the largest one in the world. The industry is divided into a number of areas like insurance, brokerages, asset management, banks, and advisors. Each of these subsectors operates in various ways. For example, in banking, there are investment banks and retail banks.
The same is true when you look at the asset management industry. There are asset managers like Warren Buffett who believe in buying assets and holding them for a long time. There are short-term managers like James Simmons who believe in buying and exiting within a short duration.
What is the Buy and Hold Strategy?
As the name suggests, a buy and hold strategy is one where the investor is interested in the long-term of a company or any other asset. Their goal is to buy at a lower price and exit the investment when the price rises. A good example of this strategy in action is Warren Buffett’s investment in Coca-Cola in 1986. Over the years, he has continued holding his stock in the company because he believes in it.
Buy and hold is often also seen as the best strategy when investing in Bitcoin, which is extremely volatile but has shown incredible returns over any 4 year time period. Buy Bitcoin and hold it for a minimum of 4 years.
Why Investors Use Buy and Hold Strategy?
There are a number of reasons why many investors use the buy and hold strategy. Some of these are:
- They believe in the company. Investors who use the buy and hold strategy have a strong belief in the company. They believe that the company will continue doing better in future.
- Room for growth. These investors believe that the company has more room to grow. For example, in a company like Alphabet, investors believe that it will find success beyond search.
- Good management. The quality of management helps to determine the success of a company. Buy and hold investors believe in the management strongly.
- Dividends. Most buy and hold investors do so because they want to continue getting dividends from the company.
- Acquisition target. Another reason for buying and holding is that the company will be acquired by another company. In the past, many investors who have bought and held US stocks have had excellent returns. This is because the value of the US stock market has more than doubled in the past five years alone.
How to Use the Buy and Hold Strategy
The type of analysis that you do when thinking of buy and hold strategies is different from the one you do for short-term investments. In the latter, the main focus is on the current price of the asset. With buy and hold, you do a more comprehensive study. The steps below show how you can analyze these companies.
- Look at the products the company sells. In this, you want to imagine the future of these products. If you believe that there is a bright future for the product or service, go to the next step.
- Look at the competitive advantage of the company. After looking at the products, look at the competitive advantage the company has in the industry.
- Look at the management. The management of the company can help you determine its future. Consider a company with a long track record of having a good slate of managers.
- Consider its valuation. Valuation is important because you don’t want to overpay for a company. As such, use the various valuation methods to find whether the company is overvalued or not.
Risks of Using a Buy and Hold Strategy
A buy and hold strategy has made people like Warren Buffet and Ray Dalio very wealthy. However, it also comes with its own risk. Some of the risks of using the buy and hold strategy are:
- Market might change. A good example of this is that of Coca-Cola. The company made a fortune in the flavored drinks industry. Today, most people in the US are avoiding flavored drinks because of their risks.
- Hard to predict the future. It is very hard to predict the future of anything. For example, it is almost impossible to predict when a recession might happen.
- Your assumptions might be wrong. For example, in valuation, there is a likelihood that your assumptions are wrong.
- Hidden problems. A good company might have many hidden problems that might cost your investment a lot of money. A good example of this is General Electric, the fallen American giant.
A buy and hold strategy is used by many investors around the world. Indeed, most successful investors warn about the risks of short-termism. However, as shown above, the strategy needs some work. For example, you need to be flexible enough to change your mind on various things. Warren Buffett has been successful in this. A good example is when he exited his investment in IBM after the fundamentals changed.