Investors are always looking for the most profitable strategy, yet what if it was as simple as buy and hold? Is there a strategy which rarely requires you to place any trades? Find out how a strategy which will allow to sleep peacefully at night, will also make you increase your capital over the long-term.
What is buy and hold
How your portfolio benefits
What work is required
Buy and hold is a concept where you buy an equity and then hold on to it for several years. As a company increases its profits, you benefit with the associated increase in its share price. Any dividends paid by the company are re-invested, so as to grow you holding – so good is the return!
Before buying, an investor following this concept will thoroughly research the company whose equity they are buying. This is to ensure that their investment has all the hall marks of a ‘winner’, which will grow over years to come.
Because of Compounding. Albert Einstein once stated:
Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.
This is one lesson from Mr Einstein that pays to listen to. Quite literally. If someone gives you £10, and offers to re-invest the interest every year for 10 years at 10% return, you end up with £137.86.
If you added another £10 per month at the same 10% interest rate, then after 10 years, your £10 would be worth £6,050…! So if you invested in a company which is growing its profits at 10%, then you can expect the share price to fly upwards.
An investor bulletin from the SEC (the agency in charge of protecting US investors) showed how damaging fees can be to your stock portfolio. Therefore paying attention to the fees a broker will charge before choosing one, is important.
Every broker will have a ‘rate card’ but some will not be forthcoming and you will have to look through a few pages to find it. Although some brokers can charge as less as half their rivals, the most effective way of reducing your costs, is to trade less often!
A buy and hold strategy is excellent for this. You will pay the initial cost of the first trade and then that is it. Most brokers will re-invest any dividends generated for less than there standard trading fee, making it economical for you.
Buying and holding an investment does not mean forgetting about it until 5 years later. You are still required to manage your investment. In particular pay attention to trading statements and the annual report.
Have there been any changes in cash flow, margin or an increase in debt? How are your investment’s key rivals performing? Just because your holding is up 30% on the year, does not mean it will keep going up. Creative accounting can appear before you know it.
Equally if it reports a poor set of results and the shares sell off, this may not mean selling, as the issue(s) could be a short-term one. The closer you follow your investment, the better feel you will have for it, and know whether short-term pains are worth ignoring.
If buy and hold works so well, why are more investors not following it? The simple answer is emotion. Imagine waking up one morning and finding one of your holdings has shot up 20% after a positive trading update. Would you not be tempted to sell and take the profit? A short-term trader, will bank the profit… leaving future profit on the table!
An exponent of buy and hold will read the trading update and understand why the profit results are so good.
This will often lead them to spot that the company is doing well and that future profit growth is coming. Their reaction will be not to take the short-term 20% profit but to stay invested, knowing that momentum trading will propel the shares even higher.
In recent living memory, no-one has made buy and hold such a success story as Warren Buffet. Yet he has also admitted that his buy and hold strategy can go wrong. He not only got it wrong by buying Tesco when it started a multi-year decline but then held on for too long. The moral is to always keep a close eye on your investment and be flexible.
Any new investor would do well to start with buy and hold, even they may be tempted to buy the dip. This would force them to focus on reading the financial statements rather than focusing on trading the share price. Investing in equities demands patience, which is rewarded when profits are compounded to your benefit!