Long-Term Investment Strategy
A long-term investment strategy refers to holding onto investments, such as stocks, bonds, mutual funds, and ETFs, for over a year. This approach requires discipline, patience, and a willingness to embrace risk for the potential of greater rewards down the line. Long-term investing, especially in stocks, is considered one of the best ways to build wealth. For instance, the S&P 500 had losses in only 13 of the past 50 years, demonstrating that the market has a strong track record of positive returns.
Key Insights
- Long-term stock investments usually outperform short-term trading strategies where investors try to time the market.
- Emotional decision-making can negatively impact investor returns.
- The S&P 500 has delivered positive returns over most 20-year periods.
- Enduring short-term market drops is often the mark of a wise investor.
- Long-term investing reduces costs and allows earnings from dividends to compound.
Superior Long-Term Returns
Investment types, known as asset classes, share similar characteristics. Examples include stocks (equities) and fixed-income assets like bonds. The best choice for an investor depends on factors like age, risk tolerance, and investment goals.
Historically, stocks have outperformed most other asset classes. From 1928 to 2023, the S&P 500 returned an average of 9.80% annually, far better than the 3.30% return from three-month Treasury bills, 4.86% from 10-year Treasury notes, or the 6.55% return from gold.
Emerging markets, though riskier, can deliver high returns. However, their performance can fluctuate dramatically. For instance, the MSCI Emerging Markets Index had an annualized return of 2.66% over the ten years ending Dec. 29, 2023.
Small and large-cap stocks have also generated above-average returns. As of Jan. 26, 2024, the Russell 2000 index (representing 2,000 small companies) achieved a 10-year return of 7.08%, while the large-cap Russell 1000 index reported an average return of 12.39% over the same period.
Weathering Market Fluctuations
Stocks are inherently long-term investments. It’s not uncommon for their value to drop by 10% or 20% in the short term. However, investors can ride out these dips and still come ahead after holding onto their investments for years or even decades.
Looking at stock market performance since the 1920s, those who invested in the S&P 500 over 20 years rarely lost money. Even with market downturns, such as the Great Depression or financial crises, a 20-year investment would typically have resulted in gains.
While past performance doesn’t guarantee future results, the historical trend shows that long-term stock investing generally produces positive results when given enough time.
Decisions Become Less Emotional, More Profitable
Despite intentions to be long-term investors, many people panic during market downturns and pull their money out to avoid further losses. By the time they reinvest, the bulk of the recovery has often occurred, resulting in missed opportunities.
A study by Dalbar, Inc. found that while the S&P 500 achieved an average annual return of 9.65% over 30 years (ending Dec. 31, 2022), the typical equity fund investor only earned 6.81%. This gap is mainly due to emotional decision-making and market timing.
Here are a couple of reasons this happens:
- Fear of Regret: Investors may worry that holding onto stocks during a downturn will lead to more significant losses. Hence, they sell to avoid potential regret.
- Pessimism During Market Declines: Optimism prevails during market rallies, but when things go south, pessimism sets in. It’s easy to get discouraged during temporary downturns, even though history shows that markets tend to rebound over time.
Frequent attempts to time the market can be costly. Sticking to a long-term buy-and-hold strategy is often more profitable.
Reduced Capital Gains Taxes
When you sell a capital asset for a profit, you incur a capital gain subject to taxes. Assets sold within a year of purchase are taxed as short-term capital gains, with rates as high as 37%, depending on your income.
However, long-term capital gains, which apply to assets held for more than a year, are taxed at much lower rates: 0%, 15%, or 20%, depending on your income and filing status. This tax break is one of the many benefits of long-term investing.
More Cost-Effective Investing
Long-term investing is also cost-effective. Holding onto stocks for extended periods helps you save on trading fees and taxes. When you sell an asset, you must report the gain to the IRS, which increases your tax liability. You can significantly reduce your tax burden by holding onto stocks for over a year.
Transaction fees, such as commissions or markups, also affect your portfolio’s value. Even though many brokers now offer commission-free trades, frequent trading can still rack up costs over time. Investors who trade less frequently also tend to save on some brokers’ maintenance fees.
Benefit from Dividend Compounding
Dividends are regular payments made by companies to shareholders. These are typically paid by blue-chip or defensive stocks—companies that perform well regardless of market conditions.
Reinvesting dividends allows investors to benefit from compound interest, where the interest or dividends earned are reinvested to generate even more returns. Over time, this compounding effect can significantly boost the value of your investments.
Best Stocks for Long-Term Holding
When building a long-term stock portfolio, factors like age, risk tolerance, and investment goals play a crucial role. Here are a few stock types to consider for long-term investing:
- Index Funds: These ETFs track a specific index, such as the S&P 500, and come with lower fees than individual stocks, making them a good option for long-term investors.
- Dividend-Paying Stocks: Stocks that pay dividends can add consistent value to your portfolio, especially if you reinvest the dividends.
- Growth Stocks: Companies with strong growth potential can deliver substantial returns but have higher risks. Investors need to be savvy when opting for growth stocks.
It’s always wise to consult a financial professional when starting your investment journey, especially if you’re new to the stock market.
The Tax Advantages of Long-Term Stock Holding
The IRS classifies gains as short-term or long-term depending on how long an asset is held. Short-term gains from assets sold within a year are taxed as ordinary income. Long-term gains from assets held longer than a year enjoy a lower tax rate of 0%, 15%, or 20%, depending on income and filing status.
How Long to Hold a Stock for It to Be Long-Term
You must hold a stock for at least 12 months to benefit from long-term capital gains taxes. Anything less is considered a short-term holding.
Can You Sell a Stock Right After Buying It?
The timing of selling a stock depends on your brokerage. Some brokers allow same-day trades, while others require you to wait until the settlement date. Excessive same-day trades can classify you as a day trader, requiring you to maintain a minimum account balance.
Conclusion
Investors with significant experience and capital may benefit from short-term trading strategies. Still, those new to the market or more risk-averse may find more success by holding stocks for the long term. Long-term investing not only helps you weather market volatility but also comes with lower tax rates, reduced costs, and compounding benefits from dividend reinvestment.
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