Long-term investment refers to holding your assets, like stocks, ETFs, or mutual funds, for an extended period of time – generally more than 3 years. In investing circles, this approach is considered to be one of the most effective ways to grow your wealth steadily over the long haul.
With that said, here are some of the key reasons why long-term investing is a better strategy to attain consistent gains – not typically possible with short-term investment techniques.
1. Long-term investment returns tend to be on the higher side
Based on historical evidence, the stock market has generally trended upward over time. So, by holding your assets for longer periods, you can give your investments more time to grow. To illustrate, over the past 91 years, the S&P 500 has experienced a variety of market conditions but only 27% of those years saw the index decline in value.
Moreover, from January 1, 1927, to December 31, 2018, 94% of 10-year periods of the S&P 500 index exhibited positive returns for investors. This suggests that those who stayed invested in the market during this interval were generally rewarded for their long-term outlook. However, missing out on just 10-40 of the best days in that period would have resulted in much lower returns for investors.
To see another example, the Russell 2000 Index has returned around 20% gains to the investors over the past 5 years whereas its past 1 year’s return stands in the negative territory (-15%). Consequently, it is a valid argument that long-term investment horizons in the stock market tend to be more conducive to positive outcomes.
2. Escape from timing the market
Timing the market is not as simple as it seems. In fact, investors who focus too much on market movements may impede their chances of even acquiring “average gains” by trying to time the market too frequently.
This is because all market participants are inherently influenced by their emotions. When the market is declining, many investors tend to withdraw their money amid a prevailing sense of pessimism and out of fear of losing their profits. And when the market rebounds, they typically re-join the bandwagon after most of the recovery has already occurred due to hesitation and uncertainty. This type of behaviour can bring disastrous consequences for long-term capital gains.
In contrast, a straightforward “long-term buy-and-hold” strategy has historically produced better results. Rather than attempting to predict market highs and lows, it is more important to remain invested for the long term. Pay attention to how long you stay invested, rather than trying to time your investments perfectly.
3. Lower capital gains tax
Just like the income tax that is cut from your income, capital gains tax is deducted when you realize a profit on your investment (though, not all jurisdictions impose this type of tax).
Generally, long-term investments – held for longer than a year – are taxed at a lower capital gains rate, which can be 0%, 15%, or 20% depending on your country of residence and income. Whereas short-term investors are taxed at a much higher short-term capital gain rate which can be as high as 40%. Ultimately, holding your stocks over the long run can lessen your tax burden and help you save money on taxes.
4. Resilient to bearish market cycles
All financial markets are subject to fluctuations, with periodic bullish and bearish phases. But a long term investment strategy can help you withstand declining market conditions that may cause short-term investors to panic.
During the financial crisis between October 2007 and March 2009, the S&P 500 experienced a drop of 46.13%. Even now, all major indices are down since the start of 2022. But let us see how a long term investment would have fared during this 2008-2022 period.
If you had invested $1000 in the S&P 500 at the beginning of 2008 and reinvested all dividends, you would have around $3,662 by the end of 2022. This would represent a total return on investment of 266.22% or an average of 9.15% per year.
Inflation during this period would have eroded the purchasing power of your money, but these returns would still have outperformed inflation, yielding inflation-adjusted gains of approximately 164.85% cumulatively, or an average of 6.79% per year
This is what the historical performance of the broader stock market suggests but, of course, past results do not guarantee future returns, and the trajectory of any particular investment can vary over time.
5. The power of compounding
If you invest in dividend-paying stocks over the long term and reinvest your dividends, you can increase the value of your investment through the power of compounding. Over time, this process can help your investment to grow exponentially, potentially leading to higher returns. Have a look at some dividend stocks you can consider buying: Top 8 Dividend Stocks To Buy Now
To better understand the effect of compounding, let us look at an example. If you purchase 50 shares of Company ABC’s stock and the company pays an annual dividend of $5 per share, you will receive a total of $250 in dividends. Under the dividend reinvestment strategy, you can buy more shares of the company with the dividend money. With the passage of time, owning more shares increase the amount of dividends you receive, allowing you to buy even more shares and gain more eventual returns.
However, it is important to remember that the base value of your investment can fluctuate, and there is always a possibility for you to lose money.
Closing thoughts
Although long term investment can offer potentially higher returns, it is not a fool-proof way to make money. Market risks and uncertainties can affect the value of an investment, and there is always the potential for an investor to lose money. In addition, it is noteworthy that the potential returns of a long-term investment strategy will depend on the specific assets in which you are investing. A bad investment can generate little or no returns, regardless of how long you hold onto it. In fact, such an investment may underperform or even become worthless. This is why it is important to carefully research and consider the potential risks or rewards of any investment before entering this sphere.
