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What’s buy-and-hold?

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‘Buying’ investments and ‘holding’ on to them for a while – no matter what’s going on in the market – is a simple but successful investment technique.

As you can tell from the name, a ‘buy and hold’ investment strategy involves buying investments and holding on to them, rather than trying to ‘time the market’ by buying low and selling high.

This is known as a ‘passive’ investment strategy because, unlike active trading, you aren’t trying to profit from short-term changes in the market.

The thinking is that the stock market goes up more often than it goes down, so your portfolio will increase in value over the long term. And, because you’re not constantly buying and selling investments, you’ll have less fees to pay.

You’re less likely to beat the market than if you took an active approach, but you’re also less likely to make mistakes.

Weighing up the evidence

Buy-and-hold hasn’t always been the golden rule. An old trading adage – ‘sell in May and go away’ – was based on the idea that markets declined seasonally, between May and October.

Most research, however, now shows it is far better to buy and hold investments throughout the year. Since 1928, US stock market index S&P 500 has posted positive returns in May to October 64% of the time – only a tick lower than the 66% of positive returns in the November through April period.

Recent research by Prudential on how markets behave over the short and longer-term suggests your risk of losing money goes down the longer you hold on to your investments. The likelihood of a loss when investing over one-year periods was 25.3%, compared with 2.5% over 10-year periods.

Passive investing has proven to be particularly effective among certain fund categories. Analysis of US-focused funds by Morningstar shows actively-managed funds have, in general, underperformed their passive counterparts over the longer term.

Why compounding matters

Buying and holding investments lets you take advantage of compounding – Albert Einstein allegedly called it the “greatest mathematical discovery of all time”.

Compounding is based on the idea that, when you earn interest and generate earnings on your investments, the next year you earn interest on your original investment, plus the interest from the first year. And on and on it goes.

The longer you invest, the more time there is for compound interest to take effect. The logic behind buy-and-hold is that compounding returns during the good times more than make up for what are usually brief market downturns.

Avoiding trading mistakes

If you try to time the market – buy investments when prices are at rock bottom and sell them when they’re sky high – there’s always the chance they could outperform their buy-and-hold peers.

But even the experts don’t get it right all the time. If you make a mistake, it could be very difficult to recover your losses.

If you combine buy and hold with regular investing by paying money into your portfolio each month, you can also benefit from pound-cost averaging (find out what this is here), which reduces your exposure to falling markets.