Buy and Hold: 5 strong advantages

The dazzling stock market legend André Kostolany once said: “Buy shares, take sleeping pills and stop looking at them. After many years you will see: You are rich.” In this article, we examine the undisputedly most boring, but probably most underestimated investment strategy: buy and hold. We show you how simply it works, where its opportunities and pitfalls lie and why it is not welcomed by the financial industry.

Focus on ETFs

We are convinced that equity ETFs are particularly suitable for the risk-based part of a buy and hold strategy. We have therefore refrained from considering individual equities or other asset classes such as real estate or bonds in this report.

What is a buy and hold strategy and how does it work in practice?

According to Wikipedia, buy and hold is an investment strategy that aims to hold investments for the long term. It also states that the basic idea behind the “buy and hold” strategy is to refrain from attempting to generate additional income by reallocating the portfolio (e.g. through stock picking, see also this chapter) once the investments have been structured in line with portfolio theory.

Simple implementation of “buy and hold”

You can find out how easy it is to structure your assets in our article “Asset allocation: the nuts and bolts of your investment”. The decisive factor here is that you divide your assets into different asset classes on a percentage basis – and use this as a long-term guide.

So instead of constantly rebalancing according to the motto “back and forth empties your pockets”, you only rebalance sporadically, e.g. annually or event-based in the event of major price fluctuations. Such rule-based rebalancing has a positive effect on returns.

You check whether the target values defined at the beginning (e.g. equity share = 50%) correspond (reasonably) with the actual values. If necessary, you make appropriate corrections in the form of transactions.

Such rule-based rebalancing also has a positive effect on returns. You can find out more about rebalancing in our article “Rebalancing your assets”.

Equity ETFs are an obvious investment vehicle for “buy and hold”

It is obvious that the return-based part of a buy and hold strategy is best implemented through equity ETFs that cover the global market.

In our opinion, the “buy and hold” philosophy also means that you don’t have to constantly check your portfolio, but can more or less sit back and relax.

We have explained what you should look out for when buying ETFs in this article.

Individual shares and “buy and hold” do not go together

We therefore consider investing in individual stocks to be unsuitable for a buy and hold strategy. This is because holding shares in individual companies requires regular monitoring of business performance and strategic direction.

And this more or less intensive involvement with a company contradicts the long-term approach of buy and hold.

This is because you must necessarily sell off a stock quickly if, for example, management errors threaten bankruptcy. An impressive example and representative of countless others every year is the former industry leader Nokia, which overslept the trend from cell phones to keyless smartphones. And disappeared from the scene in no time.

Conclusion

To summarize, a buy and hold strategy is ideally about

• long-term oriented,
• rule-based (according to predefined asset allocation),
• broadly diversified and
• passive (index-based) investing.

Can you get rich with a buy and hold strategy?

If you follow the broadly diversified buy and hold approach described above, you will participate 1:1 in the global share price performance.

Reassuring for you: With buy and hold, you do not run the risk of total loss as with individual stocks.

On the other hand, you need to be financially and mentally capable of keeping a cool head and staying invested even during the worst market turbulence (see also our article “Stock market crash 2020: What should investors do now?”).

As paradoxical as it may sound, it is precisely this “staying invested in the market” or “time in the market” that is the recipe for success of buy and hold, as the following table impressively shows.

Table 1: Performance of equity markets from 1996 to 2016 and missed opportunities due to standing on the sidelines

Indices	always invested (buy and hold)	without the 10 best trading days	without the 20 best trading days
SPI TR*	+322%	+129%	+42%
Dow Jones Eurostoxx 50	+328%	+93%	+8%
FTSE 100 TR*	+295%	+104%	+31%
S&P 500 TR*	+440%	+170%	+68%

(*TR = Total Return, i.e. with dividend. In the case of the DJ Eurostoxx 50 from the beginning of 2001 with total return. Data source: Privatbank Bellerive; published in Cash Online on 6 July 2017)

A few select days on the sidelines can therefore reduce your returns dramatically.

Research by Erwin Heri, a Swiss professor at the University of Basel, has also shown that the best and worst days are often very close together. He states that investor psychology and media hype are often misleading, especially in such turbulent stock market phases.

In other words: After days of negative price trends, many investors lose their nerve, sell and miss out on the subsequent “super days”. Finally, Heri sums up in the best buy and hold manner: “Sit back and think about your long investment horizon”.

Earn over 8 percent return in the long term with buy and hold

With a globally diversified investment using one or more ETFs, you would have generated an annualized return before taxes and costs of 8.59% from 31.12.1988 to 31.8.2021, i.e. a period of over 30 years, including all stock market crashes (source: MSCI factsheet for msci-acwi). This impressive return can even be increased by up to half a percentage point per year through rule-based rebalancing (see also our article Rebalancing your assets).

Of course, there is no absolute certainty that such a respectable level of returns can be achieved in the future.

Conversely, a buy and hold strategy also means that you refrain from trying to beat the market and achieve an excess return.

The power of compound interest with buy and hold

With the buy and hold approach, the powerful compound interest effect can also unfold its full force, as you remain permanently invested over the long term.

To illustrate this with an example calculation: an initial investment of 20,000 francs, an investment term of 30 years and an annual increase in value of 8% per year leads to an impressive final capital of 201,253 francs. A tenfold increase in your investment!

If you were to invest an additional 600 francs a month, you would be a millionaire after 30 years.

So yes, thanks to compound interest, you can get rich with a buy and hold strategy! Provided you have a fair amount of patience and invest some starting capital and/or a monthly savings installment in a global equity ETF.

Or, to repeat the quote from Kostolany mentioned at the beginning: “Buy shares, take sleeping pills and don’t look at them any more. After many years you will see: You are rich.”

Differentiation from other investment approaches

In order to sharpen the understanding of the buy and hold strategy, two well-known “counter-strategies” revolving around active investing are outlined here:

Stock picking

Stock picking using fundamental analysis

Stock picking is probably the most frequently practised investment behavior of private investors. It is often based on a fundamental stock analysis, which the stock picker uses to decide whether a stock is undervalued and therefore worth buying.

The stock picker analyzes the economic environment and takes into account one or more company-specific key figures such as the price/earnings ratio (P/E ratio).

The core of this strategy is that the stock picker believes he can predict future market developments. In other words, unlike the rest of the market, he believes he can recognize an undervalued share and the point in time when this share has reached its fair value. He then sells the stock again, repeating the procedure.

Such a strategy cannot work from the perspective of the market efficiency hypothesis, which forms the theoretical basis of modern portfolio theory. This is because it assumes that the markets are fundamentally transparent and that listed companies are therefore “correctly” valued at all times.

Stock picking using chart analysis

In addition to analyzing fundamental data, there is also stock picking using chart analysis, also known as “technical analysis”. This refers to the attempt to identify trends based on price changes and trading volumes.

In contrast to the fundamental analysis described above, chart analysis is primarily concerned with the behavior of the financial market and not with determining any undervaluation based on fundamental data.

From a scientific point of view, this topic is viewed critically by the majority and is often dismissed by its exponents as pure hocus-pocus.

Market Timing

The focus of this strategy is not so much on individual equities, but on shifting entire asset classes (“Now is the time to overweight commodities.”), markets (“Subito out of the emerging markets!”) or sectors (“Adding to insurance stocks now offers above-average return opportunities.”) based on a supposedly favorable point in time.

From a scientific point of view, this strategy also fails in the majority of cases or contradicts portfolio theory, according to which the markets are efficient and therefore all developments are constantly priced in.

At our sporadic meetings, a colleague of ours impressively demonstrates just how detrimental market timing can be to returns. He has not invested significantly in shares for around ten years. He interprets the highs regularly reached on the stock markets as overvaluation and is put off by them.

Instead, he holds an ever-increasing cash position. Always waiting to find the right entry point after all. Standing on the sidelines, he misses out on returns in the form of share price gains and dividends year after year.

So instead of “timing the market”, the buy and hold approach upholds the principle of “time in the market” (see this chapter).

Science versus stock picking and market timing

As already mentioned, active investment strategies such as stock picking and market timing have a difficult time from a scientific perspective. This is because empirically speaking, hardly any active investment strategy beats the market or the corresponding benchmark in the long term.

The science-oriented author Dr. Gerd Kommer is also critical of active trading. He sums it up in the current 5th edition of his standard work “Souverän Investieren mit Indexfonds und ETFs”, which is well worth reading:

Gerd Kommer, author

Why don’t most investors follow a buy and hold strategy?

As we have seen before, buy and hold is an extremely promising investment strategy. And yet it is not followed by the majority of private investors. We see the following three main reasons for this:

• Greed for profit
• Powerful stakeholders
• Psychological reasons

Greed for profit

To be fair, you won’t get rich quickly with a buy and hold strategy. If you tend to be impatient when investing and/or expect lunar returns, you will prefer short-term, highly speculative deals.

However, even Kostolany, the stock market speculator quoted above, does not have a universal recipe for getting rich quickly: “I can’t tell you how to get rich quickly, but I can tell you how to get poor quickly: by trying to get rich quickly.”

Powerful stakeholders

A buy and hold investor incurs significantly lower costs than an active investor. From the passive investor’s point of view, this represents a major advantage for their returns, but it is naturally not in the interests of the financial industry. On the one hand, it benefits from the more frequent transaction fees incurred through regular trading. On the other hand, it pockets relatively high fees for the bank’s own actively managed investment products.

It is therefore quite unlikely that your bank advisor will recommend ETFs to you.

Unless perhaps he has the stature and independence of Warren Buffett. The well-known star investor, who also pursues a buy and hold strategy in principle, paid the greatest possible respect to the pioneer of passive index investing, John “Jack” Bogle.

In this short and impressive film sequence, Buffett praises the extraordinary achievements of Bogle at the 2017 annual meeting of his Berkshire Hathaway conglomerate and congratulates him on his 88th birthday.

No one had created more benefits for American private investors than Bogle. In the face of fierce resistance from the powerful financial lobby, Bogle’s index funds saved billions and billions in fees from the mid-1970s onwards and therefore generated better returns than the “professionals”.

Psychological reasons

We see investor psychology as the third important reason why the buy and hold strategy is no longer popular.

We live in a meritocracy in which we learn from an early age that there is no prize without hard work. We also agree that no master has ever fallen from the sky.

In everyday life, the supposed accuracy of this popular wisdom is regularly confirmed. In work, sport or music, for example, it is usually the case that we become better and more successful at an activity if we practice it more intensively.

Alternatively – in line with the modern division of labor – we seek out a specialist, such as a trusted carpenter, hairdresser or shoemaker. And lo and behold, the result is much better than if we had done it ourselves!

That is why we intuitively assume that active investment, whether through stock picking or market timing, will achieve a better performance than a passive buy and hold strategy.

If we don’t have the time, interest or both to deal with the investment ourselves, we simply go to a specialist – in this case, an investment advisor. We accept the high fees, because performance and quality have their price. So far, so good? Unfortunately not.

This is because active investment behavior is not usually rewarded with better performance. On the contrary. One of the main reasons for this is the additional costs that are incurred due to higher fees for transactions and/or external asset management in contrast to “buy and hold”.

Advantages and pitfalls of the buy and hold strategy

Five advantages of “buy and hold”

We see the following five advantages of the buy and hold strategy, which we consistently follow ourselves out of conviction:

• Convenient and simple: Instead of regularly dealing with time-consuming market and company analyses, with Buy and Hold you are on autopilot mode, so to speak. This means that you only trade based on rules, which means you hardly have any administrative work (e.g. when filling out your annual tax return).
• Unbeatably low-cost: There are little or no transaction costs for you (see the following DEGIRO offer with free ETFs), as you do not have to constantly buy and sell with buy and hold. In addition, the choice of passive ETFs results in extremely low ongoing costs. This means that you can expect an annual TER of only around 0.2%. This corresponds to around one tenth (!) of an actively managed fund.
• Transparent and self-determined: If you invest in one or more ETFs as part of your buy and hold strategy, you can do this completely independently online with just a few clicks on numerous stock exchanges. Once you have invested, you can check the price and deviation from the index (tracking error) at any time.
• Optimal risk/return ratio: A global investment in one or more equity ETFs allows you to participate 1:1 in the performance of the world’s stock markets. Over the last three decades, this has resulted in an annual gross return of over 8 percent, including various stock market crashes, but without the risk of a total loss as with individual securities.
• Rational and scientifically sound: Countless studies prove the success of buy and hold. This scientific foundation provides security. It is therefore a thoroughly rational strategy with a successful track record.

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Five pitfalls of “buy and hold”

Where there is light, there are also shadows. You should be aware of the following five challenges of the buy and hold strategy:

• Non-intuitive: You have to accept (learn) that in investing – unlike in other areas of life – long-term inaction is a very promising approach.
• No excess returns: Some people may also find it difficult to be satisfied with market returns or to forego excess returns. At best, it helps if you remember the stock market rule “back and forth empties your pockets”.
• Too boring: A buy and hold strategy is completely unspectacular and anything but sexy. That’s a fact, and there’s nothing to gloss over. Except perhaps that ultimately the only thing that counts is the (higher) return.
• Crash resilience: Remaining stoically calm during stock market crashes and not going into panic selling mode requires a solid financial education – and a good dose of nerves (see also our article “Stock market crash 2020: What should investors do now?”)
• Resistance to financial pornography: Not letting yourself be soaped by the financial industry, i.e. consistently ignoring its daily forecasts and investment tips in particular, requires a strong will and robust financial knowledge. (The term “financial pornography” is unfortunately not an invention of ours, but comes from the aforementioned book author Gerd Kommer. By this term, he primarily means the dubious chatter of so-called financial experts who primarily pursue their own interests).

Conclusion

The buy and hold strategy based on ETFs is the simplest, cheapest and – from a scientific point of view – the investment strategy with the best risk/return ratio. It works according to the philosophy “There is strength in tranquillity”.

In our opinion, the fact that it is not practiced more frequently by private investors is due to their own greed for profit, the powerful financial lobby and, last but not least, psychological factors. After all, doing nothing is generally not a successful strategy in other areas of life.

Nevertheless, the buy and hold strategy is only suitable for investors who are disciplined, have strong nerves and are willing and able to invest for the long term.

What do you think? Whether you share our opinion or disagree with it. We look forward to your comment!

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Disclaimer

Disclaimer: Investing involves risks. You must decide for yourself whether or not you want to take these risks.

Errors excepted: We have written this article to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, should we have made any errors, forgotten important aspects and/or no longer have up-to-date information, we would be grateful if you could let us know.