When it comes to investing for your future, there are myriad paths you could take. There are more than 7,000 publicly traded stocks to choose from, many types of investment vehicles, and ample opportunities to invest on your own or seek the financial help of an advisor. Long story short, there's no set formula or path that investors are encouraged to follow to hit their retirement number...save for one: long-term investing.
Investing for the long term offers a number of advantages that investors who try to time the market, or day-trade over the short term, simply can't take advantage of. Here are nine reasons long-term investing is undeniably the smartest and easiest path to hitting your retirement number.
1. It takes emotions out of the equation
One of the greatest aspects of long-term investing is that it almost entirely removes your emotions from the equation. A market that jumps 10% in a matter of days isn't going to have you sitting on the edge of your seat to sell, and a hiccup in overseas markets that sends U.S. stocks down 3% isn't liable to send you running for the hills. Sticking with stocks over the long term allows you to instead focus on the meat and potatoes of your investments, which is the long-term growth outlook of a business, or the viability of a new business model.
2. The data shows you'll almost always be right
Historically, if you align your portfolio for the long term, you're more likely to make money. Although stocks do have a roughly 50-50 chance of rising or falling, stocks can only fall to $0, but they can rise infinitely. If you let your winners ride, there's a good chance that, over the long run, you're going to see your portfolio grow in value, especially if you focus on high-quality businesses.
3. Compounding works to your advantage
Buying stocks for the long term allows you to take advantage of compounding, or the ability to reinvest your profits (e.g., dividends) over time to generate even greater profit potential. Time is your greatest friend as an investor, and being able to reinvest a dividend at 3% can make a major difference in your wealth come retirement. As an example, simply pocketing a 3% yield will double your money about every 33 years, assuming no dividend or stock price growth. If reinvested back into more shares of the same stock, your investment would double in almost 10 fewer years!
4. It's really easy for anyone to do
One of the greatest aspects of long-term investing is that anyone can do it. It doesn't take a Warren Buffett to pick out a portfolio of well-run businesses and hang onto them for 10, 20, or 50 years. Sure, you're not always going to be right, but don't worry, even the greatest investors are wrong a third of the time -- or more. But with long-term investing there are no hassles about learning different trading styles or platforms since you won't be an "active trader."
5. You'll sleep better at night
My personal favorite is that being a long-term investor will allow you to sleep better at night. You won't have to wake up at the opening bell every day and decipher if your portfolio took a dive or exploded overnight. Chances are, the businesses you're looking to invest in are high-quality companies, and thus their propensity to be volatile will be relatively low. Finding dividend-paying stocks that other long-term income investors are seeking out is typically a good way to keep your portfolio volatility low and your stress level at a minimum.
6. It's easy to correct your investment mistakes
Remember that point above about everyone being wrong at some point? One of the important aspects of long-term investing is that it allows you to correct some, or all, of your mistakes. This doesn't mean you should collect four-leaf clovers or rabbit's feet in the hopes of your losing stocks heading higher; it means continuing to stick with companies that have demonstrated strong growth, and perhaps adding to companies whose business models are still intact but have fallen on some temporary hard times. Riding your winners over the long run tends to fix a large number of, if not all, "investing mistakes."
7. You'll pay less in taxes
Another advantage of long-term investing is that you'll pay far less in taxes than if you're an active trader. Short-term traders, or those who own their investments for a period of 365 or fewer days, pay tax at their top marginal tax rate. This could be anywhere from 10% to 39.6%. Long-term capital gains taxes are either 0%, 15%, or 20% at the highest, depending on your income. No matter how you look at it, holding your stocks for longer than a year saves you money come tax time.
8. Commissions are an afterthought
When you're an active trader, commission costs can play a big role in your trading strategy. It's not uncommon for day traders to burn through thousands of dollars in commission costs each year. As a long-term investor, you're not worried about a $10 commission fee a few times, or even a couple dozen times a year, when you add to your positions, or perhaps sell a stock once in a while. Commissions are a complete afterthought for the long-term investor since her gains can more than cancel out these minute costs over the long run.
9. Your investment risk drops
Finally, investing over the long run reduces your investment risk by removing lost opportunities. Trying to dive in and out of the market at just the right time could result in your missing big up days in the market. A study compiled by J.P. Morgan Asset Management using data of the S&P 500's largest moves between Dec. 31, 1993 and Dec. 31, 2013 showed that staying invested all 20 years would have netted a 483% return for investors of the broad-based index. Missing just the 10 biggest moves up in that timespan would have cut your return to just 191%. Miss the 30 best days in a 20-year period, and your return was less than 20%. The point is, staying invested reduces your risk of missing out on the big gains.