Rules of Investing

“Higher the Risk, Higher the Return”

This statement is not new to anyone investing in any of the financial instrument. Be it stock market, bond market, currency or any other financial instrument the term has been the motto of all the business across the globe. Equity Markets has been one of the major sectors which have been the personified version of this motto. In order to gain the maximum profit various strategies have been developed by the investors. One of the well known and globally accepted strategy is the Buy and Hold strategy also known as the Long-term Investment Strategy.

It is very important to choose a fundamentally strong company for the portfolio, as it will make a difference to the profits of the entire portfolio and will also give immense profit if held for decades. Warren Buffet, the uncrowned emperor of stock markets, too rely on a Buy and Hold strategy for investments, as its one of the most optimum options one has for increasing the wealth over the long term in every situation.

However as different kind of thinking prevails in the market, many think that Buy and Hold Strategy has taken a fair amount of beating in the recent times. People think that only the high frequency traders can make money from stock market. The average holding period of stocks has fallen from four years in the period 1926 – 1999, to 3.2 months in the present day.

Read on GWI Why investing in BRICs Debt is much more Profitable than Equity.

What is Buy and Hold

In a layman’s term Buy and Hold is a long-term investment strategy based on the view that in the long run financial markets give a good rate of return, irrespective of periods of volatility or decline. It also advocates that short-term market timing i.e. the phenomenon that one can enter the market on the lows and exit on the highs, doesn‘t work.

The underlying theory behind the strategy is:

It is impossible to consistently achieve above average returns, on a risk-adjusted basis, according to the efficient market hypothesis (EMH). Investors have access to information that will fairly value a security at all times. Therefore, it is pointless to make decisions that might result in the active trading of a security.

Thus the follower of the strategy finds no good reason to trade in stock on a daily basis. The only area of interest is the positive long term trend in the market. Opposite of buy-and-hold is the concept of intra-day trading, where in people make money in the short-term taking advantage of greater volatility.

Advantages of Buy and Hold Strategy

1. Easily Comprehendible and Implementable

2. Supported by Investment Theory

3. Reinforces the Minimum Emotions and Maximum Discipline approach

4. Outperformance of the Passive Investing over Active Investing

5. Cost-Effective as compared to Active Trading

Disadvantages of Buy and Hold Strategy

1. No upper limit to losses

2. Test of Risk Appetite–Investors may lose if they don‘t have sufficient risk appetite

3. Buy and Hold Approach may not provide Maximum Possible Returns as much as in Minute to Minute approach.

Read on GWI Bull Market or Bear Market – Two Contradictory Views.

If we look historically at the major indices around the world, we will see a consistent amount of return is offered by indices over a period of time, which is subject to certain steep falls owing to occurrence of certain big ticket events. There has been a fall in 2002 (Dot-Com Bubble Burst), 2008 (Sub-Prime Crisis) and 2011 (Curb of Quantitative Easing). Barring these years, the indices have earned a good return on investment considerably higher than the gilt edged investments.

This proves that the Buy and Hold strategy still holds true provided it’s tweaked a little. The traditional Buy and Hold strategy has given returns. This shall hold for the years to come, but as time progresses and volatility increases newer ways shall have to be discovered to keep tweaking the strategy to the right curve so that the investor profitability continues.

Also Read Indian Stock Market Casino on Steroids.