A buy-and-hold strategy is sometimes pursued by investors who are seeking to avoid paying taxes. After all, the capital gains tax is only levied on realized gains. As a result, holding an asset for the long run means its unrealized gains are not subject to this tax.
However, a buy-and-hold strategy offers far more than just tax avoidance. Indeed, it is a worthwhile strategy because it provides holdings with sufficient time to deliver on their strategy. For example, the ultimate financial impact of a company’s major acquisition or its move into a new market segment may take many years to materialize. It may take even longer for it to be evident in improving investor sentiment that lifts a company’s stock price.
Furthermore, a buy-and-hold strategy means lower commission costs compared to a more active investment plan that frequently buys and sells stocks. Moreover, it allows compounding to take hold. This can turn even modest gains made over short time periods into surprisingly large total returns over the long run.
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) CEO Warren Buffett (Trades, Portfolio) has previously shared his preference for a buy-and-hold strategy. He said, “Charlie (Munger) and I would follow a buy-and-hold policy even if we ran a tax-exempt institution.”
Application in today’s environment
Of course, today’s market environment may make it tempting to go against Buffett’s favored buy-and-hold strategy. The current bull market means many investors are likely to have experienced rapid gains on their holdings in a short period of time. They may seek to make further gains by buying and selling stocks in quick succession.
For instance, they could aim to sell relatively expensive stocks that have valuations which are above their long-term averages. They may then seek to purchase cheaper stocks they feel have greater scope to deliver capital gains due to the existence of a perceived larger discount to intrinsic value.
However, cheaper stocks do not necessarily make better investments. They may be trading at a lower price than their peers for good reason. For example, they may have a narrower economic moat that does not allow them to pass rising input costs on to customers in an inflationary environment. Or they could have relatively weak finances that are impacted negatively by rising interest payments on excessive levels of debt.
As a result, sticking with high-quality companies via a buy-and-hold strategy could be more profitable in the long run. Clearly, this does not mean investors should purchase expensive shares. But once a high-quality stock is purchased when it trades at a fair price, it could be logical to keep hold of it and allow its unrealized gains to grow.
