Buy & hold is a well-known, well-documented investment strategy. It works, and I include it as one part of the Idols Framework for building wealth. But, you must be judicious in how you use it.
I recently heard the story of David & Goliath as told by Malcolm Gladwell in his 2013 Ted Talk. His talk flips the classic story on its head and proves that Goliath was the underdog. What? The talk upset me because I thought I understood the story. Check it out here.
The lesson? Never stop confirming what you know and believe. Seek out differing and dissenting perspectives to continually test your opinions.
Until 2020, I held buy & hold investing in the highest regard. It worked well for me for over 25 years. But, the Covid stock market crash scared me. It forced me to reexamine what I thought about buy & hold.
In this post, I break down the pros and cons of buy & hold passive stock index investing. Then, I discuss how and when you should use it.
The punchline: In April 2023, I have no money invested in buy & hold. One thing needs to happen for me to get back into buy & hold…
Table of contents
- Buy & hold investing defined
- Pros of buy & hold investing
- Cons of buy & hold investing
- When to invest using buy & hold
What is buy & hold investing?
Buy & hold is a passive investment strategy that tracks a stock market index over the long term. You don’t trade stocks or exchange-traded funds (ETFs) based on market timing. Instead, investors buy and hold them regardless of changes in the stock market.
The buy & hold strategy is popular with financial independence/retire early (FI/RE) advocates. (These are my people!)
Pros of buy & hold investing
I see four key benefits of buy & hold investing.
- Buy & hold’s appeal is simplicity. Buy & hold is a mechanical strategy. Investors can tune out pundits offering advice based on market news, which is largely noise.
- Passive indexing ETFs have very low costs, especially at Vanguard. With little buying and selling, buy & holders get favorable tax treatment. These low costs increase returns. Reduced costs guarantee higher returns.
- Buy & hold stock ETFs outperform other investments like bonds, real estate, and cash savings in the long term. Since 1900, investors have reaped 8-10% returns annually (based on exactly how returns are measured).
- Buy & hold investing comes with immense social proof. The greatest investors of all time recommend it. Top buy & holders include Warren Buffett, Jack Bogle, and Peter Lynch. Visible leaders in the FI/RE movement advocate for it in podcasts and blogs.
Cons of buy & hold investing
No investment strategy is perfect. I see four major downsides to buy & hold.
- Buy & hold is inherently focused on stocks and stock ETFs. Stocks are high-performing investments, but not always the best choice throughout history.
- Buy & hold investing implies that prices don’t matter. Does buy & hold’s investment style change when stocks are at very high valuations? No. Does buy & hold respect the concept of “mean reversion”? No. (Mean reversion means that an investment’s price tends to converge to a long-run average price over time.)
- Long-term returns are just that. Ten-year periods of negative investment returns for stocks are common. Long-term losses can devastate retirement plans. You need only ask anyone starting retirement in 2000 or 2008. Buy & hold also has a large opportunity cost: investments are tied up for the long haul.
- Buy & hold ignores defensive approaches for managing risk. Buy & hold accepts market risk. Unfortunately, investment losses are asymmetric and compound exponentially. This volatility hurts returns, especially in the short term.
When to use buy & hold
Use buy & hold investing strategically when ascribing to the Idols Framework.
Consider it when:
- Stock market valuations are low enough to warrant strong future investment returns. Buy & hold investing works, but it depends on when you start your investing journey. At greater than 20x CAPE*, stock market returns over the next 10-20 years will likely be disappointing.
Here is a graph of forward-looking 10-year real investment return at given CAPE levels.
*The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a valuation measure usually applied to the U.S. S&P 500 stock market. It is the market price divided by the average of ten years of earnings (moving average), adjusted for inflation.
- Your investment time horizon is adequately long. Buy & hold investing over 10-20 years will nearly always produce a positive return. But, if you need the money in fewer than 10 years, buy & hold is not the right strategy. When nearing retirement, keep money for immediate needs in cash.
I include buy & hold investing as part of my Idols Framework for wealth creation.
But am I using it now? No. Why?
- At 29x CAPE in April 2023, I estimate a 1-2% forward-looking 10-year real return. It’s not worth taking the investment risk. There are safer investments with similar real (stated, nominal return less inflation) returns.
- I’m looking to retire in fewer than 10 years and will live on my portfolio. My investment time horizon is too short.
What must happen for me to get back in? When CAPE drops to 15x (estimated), I will put some of my long-term investment portfolio into buy & hold. But not yet!
Remember that buy & hold passive stock index investing has benefits and drawbacks. Watch CAPE levels and remember your investing time horizon. Use both to find the optimal time to use a buy & hold strategy. Most importantly, keep investigating buy & hold. Learn more. Maybe you’ll uncover your own inverted story of David and Goliath.
Reference articles
Related posts
Read more about the Idols Framework for wealth creation.
- Idols Framework overview
- Part 1: Cash savings and margin of safety
- Part 2: Starting a micro-business
- Part 3: Buy & hold index investing
- Part 4: Fast Follow Investing gives you control
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What is Fast Follow Investing?
- Start with buy & hold passive indexing.
- Then, 1) expand beyond stocks and bonds and 2) cut off severe market losses at the knees.
- Grow your lifetime savings at 12% to enjoy a 5% forever rate of withdrawal in retirement.
- Fast Follow Investing (based on Tactical Asset Allocation) is finally here for small investors like you and me.
So join me!