Not to oversimplify, but today’s investors seem to break into two camps that bring to mind that age-old tale of the tortoise and the hare. “Buy and hold” is the tortoise and “active investing” is the hare.
While active investing has gained in popularity, it is important to remember who won that famous race. Buy and hold investing has made and continues to make a lot of people a lot of money, entire fortunes in fact. But to a certain degree, which investment “style” you prefer most likely syncs with your personality type.
Successful active investing, as its name implies, requires a lot of “activity” from you and/or your manager(s). Holdings and potential buys receive constant attention and portfolios can get fine-tuned and rebalanced, literally on a daily basis. The idea is to keep a radar-like focus on the market so you take advantage of every opportunity for value increases, particularly when they are short term.
Active portfolios have the benefit of scale whereas buy and hold is typically customized for each investor’s portfolio. Done right, active investing can make investors a lot of money, but it has disadvantages, the most obvious being the need to be smarter than the market by knowing when to buy and when to sell, not to mention potential costs of doing the trades and their tax consequences.
In contrast, buy and hold bets not on the short-term success of a stock, but its ability to grow steadily while weathering inevitable market downturns, and in the long-term, to deliver exceptional performance. It is a company with a seemingly bright and long sales future and a management team with the skills and intent to take advantage of innovations that will grow the company.
Too often buy and hold is portrayed as the opposite of active investing; a static, even stodgy low-growth way to invest. But that simply is not the case for a carefully constructed buy and hold portfolio, where it is not uncommon for some stocks to increase as much as 1,000 percent over the long term.
One misstep buy and hold investors sometimes make is to ignore whole new categories of investment that come along. If you review mature buy and hold portfolios, you can spot different “vintages” among them. 1970s portfolios may be full of natural resources stocks, while 1980s portfolios focused on consumer staples stocks. 1990s and 2000s portfolios may be loaded with healthcare and tech stocks.
The best way to avoid having a “vintage” portfolio is to continually add buy and hold stocks over time in burgeoning industries poised to flourish. However, a buy and hold portfolio is still organic. Which is a polite way of saying, stuff happens. Companies can be acquired, or go out of business. In addition, you and your managers need to monitor your investments to cull out underperformers to make sure your patience pays off in the end.
Finally, if a less frenetic investing approach suits your style, a key advantage of buy and hold is tax efficiency. This is so because generally capital gains in a taxable account can be deferred–or avoided entirely by gifting of securities with long term capital gains to a charity, subject to certain limitations, or by a cost basis step up upon the death of the owner.
But, stuff does happen, so perhaps a better way to describe the “tortoise” style of investing is buying with an intention to hold—but also a determination to win.