Buy-and-Hold Investing vs. Market Timing: An Overview
If you were to ask 10 people what long-term investing meant to them, you might get 10 different answers. Some may say 10 to 20 years, while others may consider five years to be a long-term investment. Individuals might have a shorter concept of long-term, while institutions may perceive long-term to mean a time far out in the future. This variation in interpretations can lead to variable investment styles.
For investors in the stock market, it is a general rule to assume that long-term assets should not be needed in the three- to five-year range. This provides a cushion of time to allow for markets to carry through their normal cycles.
However, what's even more important than how you define long-term is how you design the strategy you use to make long-term investments. This means deciding between buy-and-hold (passive management) investing or marketing timing (active management).
Key Takeaways
Buy-and-hold involves buying securities to hold for a long-term period, although the definition of long-term varies based on the investor.
Market timing includes actively buying and selling to try and get into the market at the most advantageous times while avoiding the disastrous times.
Research shows that long-term buy-and-hold tends to outperform, where market timing remains very difficult. Much of the market’s greatest returns or declines are concentrated in a short time frame.
There is an in-between strategy that combines buy-and-hold with active security selection; examples include allocation adjustments and tax management.
Buy-and-hold strategies, in which the investor may use an active strategy to select securities or funds but then lock them in to hold them long term, are generally considered to be passive in nature.
Figure 1 shows the potential benefits of holding positions for longer periods of time. According to research conducted by Charles Schwab Company in 2012, between 1926 and 2011, a 20-year holding period never produced a negative result.
When it comes to market timing, there are many people for it and many people against it. The biggest proponents of market timing are the companies that claim to be able to successfully time the market. However, while there are firms that have proved to be successful at timing the market, they tend to move in and out of the spotlight, while long-term investors like Peter Lynch and Warren Buffett tend to be remembered for their styles. Figure 2 below shows returns from 1996 to 2011.
Figure 2: S&P 500, 1996-2011
Source: SchwabCenter for Financial Research
This is probably one of the most commonly presented charts by proponents of passive investing and even asset managers (equity mutual funds) who use static allocation but manage actively inside that range. What this data suggests is that timing the market successfully is very difficult because returns are often concentrated in very short time frames. Also, if you aren't invested in the market on its top days, it can ruin your returns because a large portion of gains for the entire year might occur in one day.
Special Considerations
On the opposite side of the spectrum, numerous active management techniques allow you to shuffle assets and allocations around in an attempt to increase overall returns. There is, however, a strategy that combines a little active management with the passive style.
A simple way to look at this combination of strategies is to think of a backyard garden. While you may plant different crops for different results, you will always take the time to cultivate the crops to ensure a successful harvest. Similarly, a portfolio can be cultivated along the way without taking on a time-consuming or potentially risky active strategy.
A good example of this method would be in tax management for taxable investors. For example, a security or fund may have an unrealized tax loss that would benefit the holder in a specific tax year. In this case, it would be advantageous to capture that loss to offset gains by replacing it with a similar asset, as per IRS rules. Other examples of advantageous transactions include capturing gains, reinvesting cash from income, and making allocation adjustments according to age.
Key Differences
If volatility and investors' emotions were removed completely from the investment process, it is clear that passive, long-term (20 years or more) investing without any attempts to time the market would be the superior choice. In reality, however, just like with a garden, a portfolio can be cultivated without compromising its passive nature.
Historically, there have been some obvious dramatic turns in the market that have provided opportunities for investors to cash in or buy-in. Taking cues from large updrafts and downdrafts, one could have significantly increased overall returns, and as with all opportunities in the past, hindsight is always 20/20.
Key Takeaways. Buy-and-hold involves buying securities to hold for a long-term period, although the definition of long-term varies based on the investor. Market timing includes actively buying and selling to try and get into the market at the most advantageous times while avoiding the disastrous times.
Instead of trading shares based on stock market timing, investors buy stocks and hold onto them despite any market fluctuation. Active investing relies on real-time market pricing; investors sell their shares when stock prices are high and buy new shares when prices are low.
In the words of Kenneth Fisher, “Time in the market beats timing the market.” Academics have demonstrated time and again that systematically investing in factor portfolios would have outperformed the market over the long term.
Yes, the Buy and Hold strategy is particularly well-suited for retirement planning. Its long-term nature aligns with the typical investment horizon of retirement planning, allowing for capital appreciation and the benefits of compounding returns over several decades.
"Buy and hold can result in significant long-term capital gains, which are often taxed at a lower rate than short-term gains," says Collins. On the other hand, he adds, it may take longer for buy-and-hold investors to see returns, compared with using a more active trading strategy.
The biggest drawback of this strategy is the large opportunity cost attached to it. To buy and hold something means you are tied up in that asset for the long haul. Thus, a buy and holder must have the self-discipline to not chase after other investment opportunities during this holding period.
Market timing is the practice of anticipating market lows and market highs to buy and sell (or sell short) stocks, exchange-traded funds (ETFs), or other assets at the most favorable prices. Simply put, it's about trying to pinpoint price tops and bottoms to optimize your market entries and exits.
A perfect market timing strategy needs to know, with certainty, the future returns of the assets that are eligible for investment. Armed with this information, the perfect market timing strategy always chooses the highest returning asset to invest in.
Perfect market timing, investing $2,000 once a year at the lowest point. Investing $2,000 per year on the first trading day. Dividing $2,000 into 12 pieces and investing at the beginning of every month. The opposite of number one, investing $2,000 at the highest point.
It requires a trader to consistently follow up on market movements and trends. It entails higher transaction costs and commissions and includes a substantial opportunity cost. Market timers exit the market during periods of high volatility.
Buy and hold is a long-term passive strategy where investors keep a relatively stable portfolio over time, regardless of short-term fluctuations. Buy and hold investors tend to outperform active management, on average, over longer time horizons and after fees, and they can typically defer capital gains taxes.
Buffett has pursued a buy-and-hold strategy regardless of short-term market fluctuations and changes in the value of Coca-Cola Company shares. For example, while these shares lost 54% in price from July 1998 to February 2003 inclusive, the investor continued to hold them in his portfolio.
Buy and hold is a good strategy for some, but as you age, risk management needs to takeover. The risks that you can face when you're younger shouldn't be a part of your portfolio later on in life when you have proper risk management in place.
Buy-and-hold involves buying securities to hold for a long-term period, although the definition of long-term varies based on the investor. Market timing includes actively buying and selling to try and get into the market at the most advantageous times while avoiding the disastrous times.
Because speculative stocks are very risky and short-term market movements are practically impossible to predict, one of the best investment methods is to pick high-quality stocks and hold them over the long term.
If you hold a stock for one year or longer, your gain will be taxed at the long-term capital gains tax rate. But if you hold a stock for less than one year before selling it, your gain will typically be taxed at your ordinary income tax rate.
Investors must consider several factors before buying or selling an investment, including how much risk they're willing to take and when they'll need the money. In other words, investors should have a financial plan that outlines their investment and financial goals for the short and long term.
Timing the market is a strategy that involves buying and selling stocks based on expected price changes. Prevailing wisdom says that timing the market doesn't work; most of the time, it is very challenging for investors to earn big profits by correctly timing buy and sell orders just before prices go up and down.
Generally speaking, a hold rating means the stock isn't going to overperform or underperform to an extent that makes it a must-buy or must-sell. If you already have a position in the stock, there's not much to gain from selling it.
Buy and hold refers to an investing strategy practiced favorably by passive investors. An investor using a buy-and-hold strategy actively selects stocks, but once they hold a position, they usually ignore the day-to-day and potentially even month-to-month fluctuations in the stock's price and technical indicators.
Introduction: My name is Horacio Brakus JD, I am a lively, splendid, jolly, vivacious, vast, cheerful, agreeable person who loves writing and wants to share my knowledge and understanding with you.
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