Buy and hold: Rethinking long-term investment strategies

Investing Insights

As long as markets have existed, investors have tried to maximize gains and minimize losses by timing the market.

In theory, investors believe they should buy when prices are low but rising and sell when prices are high but falling. However, to time the market perfectly, you have to be successful twice: once when you buy and then again when you sell. Getting the timing right on both ends is doubly difficult. Plus, every time you trade, you incur costs such as brokerage fees and taxes, which can quickly reduce any additional returns you’ve gained on both the purchase and the sale.

Instead of trying to time the market, consider spending time in the market by buying stocks and holding on to them regardless of market fluctuations. This is a long-term buy-and-hold investment strategy.

Here are 5 reasons to consider this approach and how you can get started.

1. Investments can grow despite market fluctuations

The U.S. stock market volatility can be intimidating — but history shows the market has been able to recover from declines and still provide investors with a positive return on long-term investments. In fact, over the past 35 years, the market has posted a positive annual return in nearly eight out of every 10 years.1

2. Investments may participate in the market’s biggest days

A buy-and-hold strategy can help investors avoid missing out on the market’s biggest days. Historically, a large share of the stock market’s gains and losses occur in just a few days of any given year.

For example, in 2016, U.S. stocks experienced a sharp drop after the Brexit vote in June, then again during the run-up to the U.S. presidential election in November. These major events spurred several of the market’s biggest days in 2016.

3. Recoup losses faster

For most investors, a buy-and-hold strategy can result in quicker loss recuperation, even after a bear market when a major index like the S&P 500 falls by more than 20 percent from its recent high.

Here’s an example. Imagine you invested $1,000 in the S&P 500 on January 1, 2008. That year, the S&P 500 lost 37 percent of its value.2 So, at the end of 2008, your investment was worth $630. Consider the differing outcomes depending on whether you used a buy-and-hold strategy or chose to reinvest $630 into a savings account with a 3 percent interest rate, compounded monthly.

Using a buy-and-hold strategy, you would have recouped your losses by 2012, even without making additions to your original investment. With your funds in the savings account, in this example, it would take 16 years to recoup your losses and cross the $1,000 threshold.

Sources: YCharts — S&P 500 Annual Returns Historical Data; Bank Rate – Simple Savings Calculator. For illustrative purposes only – indexes are unmanaged and are not available for direct investment.

4. Grow with compounding interest

A buy-and-hold strategy can also help investors take advantage of compounding. While past performance is not a guarantee of future returns, the S&P 500’s inflation-adjusted average annual return is about 7 percent.3 This means, on average, the index’s value is 7 percent higher at the end of the year than it was at the beginning. These gains accumulate over time and can provide an advantage to those who start investing early.

5. An early start could mean more dividends

Investors often try to wait for the “right” time to start putting money into the stock market. But the longer they delay their investing, the longer they’re missing out on company dividends.

Dividends are not to be underestimated. These individual payouts might seem small — especially when you’ve been investing for only a few years — but more than 40 percent of the historical gains in the S&P 500 have come from dividends.2

As an investor, you can choose to cash in your dividends as soon as they’re available, or you can opt to reinvest your dividends back into the market, manually or automatically.

Automatic dividend reinvestment expands your portfolio with minimal effort on your part. As you reinvest your dividend payouts, you’ll purchase additional shares that earn additional dividends. In other words, dividend reinvestment can help you leverage the magic of compound returns. Accumulating dividends can add significant value to your portfolio.

Still, it’s important to understand two potential downsides to automatic dividend reinvestment.

  • The dividends you receive from Company A are automatically reinvested to purchase more shares of Company A. This takes away your option to reinvest dividend payouts from Company A into Company B, even if Company B is more attractive and would accelerate your portfolio’s growth.
  • If you automatically reinvest dividends, you still need to account for taxes. When you receive a dividend payment, that amount of the dividend is taxable income, even if the dividends were reinvested into the same stock automatically.

If you’re investing for retirement, you might want to turn off dividend reinvestment once you’ve stopped working. That way, you’ll receive cash distributions that you can put toward living expenses. Before retirement, however, reinvesting dividends can help maximize your gains and set you up for the potential to receive higher payouts later on.

Choose your start to long-term investing

As you begin your buy-and-hold strategy, you must first decide how and when you want to buy your investments. You can choose to buy your investments all at once — lump sum investing – or begin an investment schedule — dollar cost averaging.

  • Dollar cost averaging is the practice of contributing a fixed dollar amount into an investment on a regular schedule. It allows you to enter the market even if you have only a small amount to invest each month.

As an example, let’s say you invest $300 per month for one year in an index fund that covers a broad range of stocks. When values — the prices you pay for your shares — are higher, your $300 contribution will purchase fewer shares. When values are lower, your contribution will purchase more shares. Over the course of a year, you’ll most likely pay an average price for the investment overall. Therefore, you’ve reduced the risk of repeatedly buying at peak values.

With this approach, you can start investing early and take advantage of compound returns. It’s important to note that dollar cost averaging does not guarantee you’ll pay less for your investments compared with a one-time buy. But investing on a regular schedule helps develop a habit of putting money away. Plus, you can set up automatic contributions to make regular investments.

  • Lump sum investing is exactly what it sounds like. If you have a lump sum to invest, you can invest it all at once. A lump sum approach requires an investor to have a larger sum of money to invest. You may receive a lump sum of cash through the sale of a family business, sale of company stock, inheritance, proceeds from an insurance policy, or by other means.

The sooner you invest your sum of money, the sooner you begin earning returns, especially, in this case, compound returns.

Oftentimes, emotions can sabotage a buy-and-hold, long-term investment strategy. Overconfidence might lead you to trade too frequently while fear of loss might cause you to hang on to investments that no longer support your goals or earn a sustainable return. However, when you invest more regularly and focus on the long-term, you can feel confident that you’re steadily working toward your goals.

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