Contrast that with trading, which could see an investor risk the permanent loss of their capital if they buy at the top and then give up and sell at the bottom, locking in losses.
Not missing out on even bigger gains
One of the biggest mistakes many beginning investors make is selling too early, which can cause them to miss out on much greater returns over the long term. For example, while it might be tempting to cash in after a 10% or even 100% gain, great companies tend to continue producing winning returns.
Benefiting from compound interest
While stocks can correct and crash without warning, they generally move higher. As noted earlier, the S&P 500 has historically produced a more than 10% total annualized return. Despite all the volatility, that general upward trend adds up over time. For example, investing $550 a month in an S&P 500 index fund has historically grown into a $1 million nest egg in about 30 years.
Saving on taxes
Stock sales are taxable unless they're made in a tax-deferred retirement account like an individual retirement account (IRA). For stocks held long-term (more than a year), the capital gains tax rate is either 0%, 10%, or 20% depending on your income and tax bracket.
However, short-term capital gains taxes are much higher because they correspond to an investor's ordinary income tax bracket, which ranges between 10% and 37%. Taxes can eat a significant portion of an investor's gains if they're trading in and out of stocks, especially those in higher tax brackets.
While buying and holding over the long term generally yields the best returns, it's also essential to know when to sell stocks. Situations where selling is a smart move include when the reason you bought the stock no longer applies, the company is being acquired, you are rebalancing your portfolio, you need the cash to make a big purchase, or you see a better investment opportunity.
