2 lucrative reasons I like buy and hold investing

Light trails from traffic moving down The Mound in central Edinburgh, Scotland during December

With markets jumping around a lot lately, some traders have been moving in and out more often than normal. As a private investor, not a short-term trader, I prefer a buy and hold investing style. Here are two reasons I like it.

Lower transaction costs

A lot of new investors do not realise how hurtful transaction costs can be to their returns. A couple of percentage points here and there does not sound like much. But it soon adds up, especially as often percentage trading fees also have a minimum amount.

It is not just trading fees, commissions, and stamp duty that can eat into profits, either. There is also usually a difference between the buying and selling price of a share. This is similar to the ‘spread’ one sees when buying a foreign currency, where there is a gap between the buying and selling rate. The spread on share prices can be miniscule for large companies, but it can make quite a difference when investing in smaller ones.

Take Income & Growth Venture Capital Trust as an example. As I write, I can buy shares in the £116m company for 92p each. But if I sell them at the current price, I would only receive 89p per share. In other words, if I bought the shares, I would need them to increase by 3.4% just to be able to sell them at the price I paid for them! On top of that, I would likely need to pay trading fees and other costs — twice. If I buy shares to hold, I would still need to pay such costs when I buy them. But my buy and hold investing style can give the shares a longer time frame in which they can, I hope, increase in value more than I need to pay for charges. That is one reason I like this approach to investing.

Buy and hold investing

If a share I buy really does have a strongly performing business that helps boost its share price, holding it longer should improve the size of my total return – sometimes dramatically.

As an example, imagine I invest £500 in a company and its shares go on to increase by 9% a year. Although that might not sound much, managing a 9% share price increase year after year is quite a feat. Each year the baseline is getting bigger.

The power of compounding

After one year, my shares would be worth roughly £547. But if I wait for five years, they would be worth around £783. After 10 years, the value would be around £1,226. That already sounds very attractive to me — but after 30 years, my shareholding would have soared in value to £7,365. That is the second reason I like buy and hold investing: the power of compounding.

What is the point of selling up after one year with my £47 gain (before commissions and fees), to try and find another share growing at 9% when I could just keep my money in the one that is already growing 9%? Past performance is not necessarily a guide to what will happen in future. But if I have identified a business I think has the potential to make high profits for decades into the future, financially the rewards will hopefully pile up more if I am willing to hold the shares for the long term.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.