When it comes to investing, many market experts will recommend holding stock for the long term. And it’s not specific to any one investor category—it’s across the board, from novices just starting out, well-established investment firms.
In this article, we’ll look at why experts recommend holding stocks for the long-term, and the dangers of unsustainable, short-term investments.
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You get better long-term returns
Short term share trading relies on your expertise, agility, time investment, and a healthy dose of luck. On the other hand, long term share investment relies more on patience — and is likely to deliver better returns.
Stocks typically increase in value over time. Economies generally move upwards, as does inflation. So the longer you hold your stocks for, logically they’ll increase in value.
In theory, there’s no limit to the prices your stocks can increase to. And from a risk management point of view, the lowest they can go is $0—and it’s only upwards from there.
Also, by holding stocks you have the ability to compound your profits. That is, to reinvest your profits back into the shares. This enables you to achieve even greater profit potential.
Historically shares have been shown to be a very good long term investment, averaging about 9.5% per annum return over 10 year periods. So when investing in shares for the long term, you typically need a 5 to 10 year time horizon to begin to see the full benefits.
Investing in shares for this length of time is easier, too. Despite what some may say, it’s rather hard to time the market (that is, buy at the bottom and sell at the top). So it’s easier, and safer, to take a long-term approach, and continue to buy shares and stocks over the years.
The longer you hold them, the more chance they have to grow in value
It’s a theory that has logical merit, and is known as dollar-cost averaging. Using this method, you invest equal amounts of money into your stocks at regular intervals, regardless of their price. The idea behind this method is to avoid investing at the wrong time, with one lump sum investment.
As the price will likely change each time you invest, the investment itself doesn’t feel the effects of volatility as much. And over time the regular investments lessen the overall impact of volatility.
You’ll invest at better times, and you’ll invest at less profitable times. But your investment is always increasing, and the profits you make off the good times offset the losses during the bad.
It’s a numbers game — the more money you invest, the more your stock increases, and the greater your returns will be.
Greater ability to ride out the lows — and the highs
By its very nature the share market is volatile. It rises and falls throughout the day.
But while the market fluctuates, the amount of stocks you hold doesn’t. And when it comes to investing in stocks, it’s important to remember that you only make a loss when you sell.
So when the market faces a downturn, like the 2007 GFC or at the start of the COVID-19 pandemic, you don't actually have to sell your shares. Yes, their price may drop. But history tells us that the market will bounce back.
You can ride out any share market lows by being disciplined and not panicking. The people that don't panic are the people that have a long term plan. They’re not looking for short term gains. If you hold a well-planned portfolio of stocks, the price likely will increase again.
But conversely, you also need to ride out the highs. Don't get too excited when markets are at high prices. People often get over-excited and buy as many shares as they can. But why buy when the prices are high? Again, if you stay disciplined and have cash set aside, you can buy shares for lower prices when the market has a pull back.
Again, you’re not trying to time the market. You’re trying to make your stocks do the work for you. Opting for long term investments ensures that you don’t fall victim to highs and lows, and get the most value out of your stocks.
Enjoy a lower capital gains tax rate
Capital gains tax covers all your assets, which includes the profit you make from stocks, too. So if you buy stocks for a low price, and sell them at a good profit, you pay tax on the profit you make. And, as you can expect, this cuts into a lot of the value of holding stocks.
That’s why holding stocks for the long term is a better idea: you can take advantage of capital gains reductions. If you hold shares (or any investments) for more than 12 months you’re eligible to receive a 50% reduction in the capital gain that forms part of your taxable income.
So if you choose to sell your stocks within a short time period, you’re required to tax on the full capital gain. And whether you sell for a large profit or not, this still eats away at the profit you should be receiving.
Investing for the long term allows you to avoid this.
Reduce trading costs
Trying to time the market is a fraught affair, and actually ends up generating more costs for your portfolio. When you trade, you pay transaction costs for every action you take. So when you buy and sell stocks and shares, you pay a fee every time you do this.
This is where a long-term approach becomes beneficial. The longer you hold your shares for, the less you pay in trading costs. By lengthening the time over which you hold the shares—by not touching them for 5 or 10 years—you only pay transaction costs when you buy more, or when you sell.
And when you do buy, those costs will generally be offset by the potential gains from holding the shares for that amount of time.
The drawbacks of holding stocks for the short term
It’s easy to see that holding stocks for the long term has its benefits. If this wasn’t enough to convince you that stocks are a long-term game, let’s look at the drawbacks of holding shares for a short period of time.
- The cost to hold them is higher, as you’re performing more transactions over the course of your stocks’ lifetime.
- You pay higher taxes, as you’ll have to pay tax on the full capital gain if you sell the stocks within a 12-month period.
- It reduces returns, as the stocks have less time to mature, and earn less money for you.
- They’re harder to manage, you need much more knowledge and expertise to skillfully manage a short-term investment.
The final word
When it comes to investing in stocks, we believe that it’s a long-term investment. By holding stocks for a 5-10 year period, or longer, this allows you to:
- Grow the value of your stocks;
- Receive better returns;
- Enjoy lower taxation;
- Reduce your trading costs; and
- Safely navigate market volatility.