Buy and hold refers to a passive investment strategy where an investor buys a stock or other type of security such as an ETF and holds them for an extended period. Typically, buy and hold stocks almost always outperform the market regardless of the short-term price movements and technical indicators.
Today, we will examine the benefits of using a buy and hold strategy:
What are Capital Gains?
A capital gain is the profit you make after selling your asset, such as a stock investment. Capital gain is calculated as the total sale price less the original cost of the asset. To understand the benefits of a buy and hold strategy, we must first understand what capital gains are.
Capital gain tax refers to a government fee imposed on investors' profit after selling some assets such as stock investments or real estate property. The capital tax only becomes due after you sell your investment, meaning that you won't owe any tax as long as you continue to hold on to your investment.
What Is the Difference Between Short-Term vs. Long-Term Capital Gains?
There are two types of capital gains that you can be taxed under. The first one is short- term gains, which is the gain that occurs when you hold onto an asset for less than a year. The second type is long-term capital gains which is any asset that has been held longer than a year.
The Tax Implications of Short vs. Long Term Capital Gains
The federal government imposes taxes on short- and long-term capital gains, but the tax implications differ substantially. Long-term capital gains are taxed according to graduated thresholds for taxable income at 0%, 15%, or 20%. While short-term capital gains are taxed as ordinary income, which is dependent upon your tax bracket.
The main benefits of holding a company at least 1yr + 1 day are:
Cost savings: Long-term capital gains are generally always taxed at a lower rate than short-term capital gains. The current long-term capital gains rate stands at 20 percent in the highest bracket. However, you can qualify for a 15 percent rate or less. Notably, married taxpayers earning $80,000 and filing jointly will pay a 0 percent capital gains tax rate for the year 2020.
Risk reduction: The passive investing strategy reduces the "manager risk." The "manager risk" is the risk that you take when you actively manage your portfolio. In essence, when you go for long-term capital gains, you reduce the risk of human error.
When to Avoid Your Long-Term Strategy for Short-Term Gains
There are times when a short-term investment strategy is more attractive than long-term gains.
These include:
Changes in the company: If there are changes in the parent company, including changes in management, product or service line, and regulatory issues, it may be wise to go for a short-term strategy. These changes may affect the company's bottom line in the long run.
Price vs. Value: If the stock price has exceeded the perceived intrinsic value, it may be an excellent time to sell. This is a good strategy when looking to rebalance your portfolio. Rebalancing involves selling a bit of what has done well and reinvesting elsewhere to decrease exposure to the area that is performing over a given period. Rebalancing also helps keep your portfolio on track with the original mix of investments.
You have a Better Option: If you need urgent funding for what you perceive to be a better investment, you can sell your stocks and use the money to finance your new investment.
Key Takeaway
Research looking into historical asset class returns reveals stocks have
outperformed almost all other asset classes.
If trading in stocks is in your plans, consider a buy and hold strategy that offers several benefits. With this strategy, you are sure to get an opportunity to ride out some of the usual market fluctuations to generate a better long-term return. If you need help getting started,
contact us today.