Benefits of Holding Stocks for the Long Term

A long-term investment strategy entails holding investments for more than a full year. This strategy includes holding assets like bonds, stocks, exchange-traded funds (ETFs), mutual funds, and more. It requires discipline and patience to take a long-term approach. That's because investors must be able to take on a certain amount of risk while they wait for higher rewards down the road.

Investing in stocks and holding them is one of the best ways to grow wealth over the long term. For example, the S&P 500 experienced annual losses in only 13 of the last 50 years, dating back to 1974, demonstrating that the stock market generates returns much more often than it doesn't.

Better Long-Term Returns

The term asset class refers to a specific category of investments. They share the same characteristics and qualities, such as fixed-income assets (bonds) or equities, which are commonly called stocks. The asset class that's best for you depends on several factors, including your age, risk profile and tolerance, investment goals, and the amount of capital you have. But which asset classes are best for long-term investors?

If we look at several decades of asset class returns, we find that stocks have generally outperformed almost all other asset classes. The S&P 500 returned a geometric average of 9.80% per year between 1928 and 2023. This compares favorably to the 3.30% return of three-month Treasury bills (T-bills), the 4.86% return of 10-year Treasury notes, and the 6.55% return of gold, to name a few.

Emerging markets have some of the highest return potentials in the equity markets, but also carry the highest degree of risk. This class historically earned high average annual returns but short-term fluctuations have impacted their performance. For instance, the 10-year annualized return of the MSCI Emerging Markets Index was 2.66% as of Dec. 29, 2023.

Small and large caps have also delivered above-average returns. For instance, the 10-year return for the Russell 2000 index, which measures the performance of 2,000 small companies, was 7.08% as of Jan. 26, 2024. The large-cap Russell 1000 index had an average return of 12.39% for the last 10 years as of the same date.

You Ride Out Highs and Lows

Stocks are considered long-term investments. This is, in part, because it's not unusual for stocks to drop 10% to 20% or more in value over a shorter period of time. Investors have the opportunity to ride out some of these highs and lows over a period of many years or even decades to generate a better long-term return.

Looking back at stock market returns since the 1920s, individuals have rarely lost money investing in the S&P 500 for a 20-year time period. Even considering setbacks, such as the Great Depression, Black Monday, the tech bubble, and the financial crisis, investors would have experienced gains had they made an investment in the S&P 500 and held it uninterrupted for 20 years.

While past results are no guarantee of future returns, it does suggest that long-term investing in stocks generally yields positive results if given enough time.

Decisions May Be Less Emotional, More Lucrative

Let's face it, we're not as calm and rational as we claim to be. In fact, one of the inherent flaws in investor behavior is the tendency to be emotional. Many individuals claim to be long-term investors until the stock market begins falling, which is when they tend to withdraw their money to avoid additional losses.

Many investors fail to remain invested in stocks when a rebound occurs. In fact, they tend to jump back in only when most of the gains have already been achieved. This type of buy high, sell low behavior tends to cripple investor returns.

According to Dalbar's Quantitative Analysis of Investor Behavior study, the S&P 500 had an average annualized return of 9.65% during the 30-year period ending Dec. 31, 2022. During the same time frame, the average equity fund investor experienced an average annual return of about 6.81%.

There are a few reasons why this happens. Here are just a couple of them:

• Investors have a fear of regret. People often fail to trust their own judgment and follow the hype instead, especially when markets drop. People tend to fall into the trap that they'll regret holding onto stocks and lose a lot more money because the stocks drop in value so they end up selling their holdings to assuage that fear.
• A sense of pessimism when things change. Optimism prevails during market rallies but the opposite is true when things turn sour. The market may experience fluctuations because of short-term surprise shocks, such as those related to the economy. But it's important to remember that these upsets are often short-lived and things will very likely turn around.

Investors who pay too much attention to the stock market tend to handicap their chances of success by trying to time the market too frequently. A simple long-term buy-and-hold strategy would have yielded far better results.

Lower Capital Gains Tax Rate

Profits that result from the sale of any capital assets end up in a capital gain. This includes any personal assets, such as furniture, or investments like stocks, bonds, and real estate.

An investor who sells a security within one calendar year of buying it gets hit with taxes on any gains at a rate that's the same as for ordinary income. These are referred to as short-term capital gains. Depending on the individual's adjusted gross income (AGI), this tax rate could be as high as 37%.

Any securities that are sold after being held for more than a year result in long-term capital gains. The gains are taxed at a maximum rate of just 20%. Investors in lower tax brackets may even qualify for a 0% long-term capital gains tax rate.

More Cost-Effective

One of the main benefits of a long-term investment approach is money. Keeping your stocks in your portfolio longer is more cost-effective than regular buying and selling because the longer you hold your investments, the fewer fees you have to pay. But how much does this all cost?

As we discussed in the last section, you save on taxes. Any gains from stock sales must be reported to the Internal Revenue Service (IRS). That ends up increasing your tax liability, which means more money out of your pocket. Remember, short-term capital gains can cost you more than if you hold your stocks for a longer period of time.

Then there are trading or transaction fees. How much you pay depends on the type of account you have and the investment firm that handles your portfolio. For instance, you may be charged a commission or markup, where the former is deducted when you buy and sell through a broker while markups are charged when the sale is directed through their own inventory. These costs are charged to your account whenever you trade stocks. This means your portfolio balance will drop with every sale you make.

In 2024, many active investors make trades through online brokerages that provide fee-free transactions. In these cases, you may not incur costs to complete some or all of your trades. However, it's still important for investors to weigh out the value of the time they spend on trades in comparison with the difference in performance between an active and a longer-term, buy-and-hold type of strategy.

Benefit From Compounding With Dividend Stocks

Dividends are corporate profits distributed by companies with a track record of success. These tend to be blue chips or defensive stocks. Defensive stocks are companies that do well regardless of how the economy performs or when the stock market drops.

These companies pay regular dividends—usually every quarter—to eligible shareholders, which means that you get to share in their success. While it may be tempting to cash them out, there's a very good reason why you should reinvest the dividends into the companies that actually pay them.

If you own any bonds or mutual funds, you'll know about how compound interest affects your investments. Compound interest is any interest calculated on the principal balance of your stock portfolio and any earlier interest you earned. This means that any interest (or dividends) that your stock portfolio accumulates compounds over time, thereby increasing the amount in your account in the long run.

Best Types of Stocks to Hold for the Long-Term

There are several things to consider when you want to purchase stocks. Consider your age, risk tolerance, and investment goals, among other things. Having a handle on all of this can help you figure out the kind of equity portfolio you can create in order to meet your goals. Here's a general guide you can follow as a starting point that you can tailor to your own situation:

• Choose index funds. These are ETFs that track specific indexes, such as the S&P 500 or the Russell 1000, and trade just like stocks. But unlike stocks, these funds come with a lower cost and you won't have to pick and choose specific companies in which to invest. Index funds give you similar returns to the indexes they track.
• Consider dividend-paying stocks. These types of stocks can help add value to your portfolio, especially when dividends are reinvested.
• Companies with high growth can boost your portfolio. Growth stocks tend to be associated with companies that are able to generate a significantly higher revenue and at a faster rate than others. They are also better equipped to deliver strong earnings reports. Keep in mind, though, that this degree of growth comes with a higher level of risk, so you'll have to be a little savvier than novice investors if you want to go this route.

As always, it's a good idea to consult with a financial professional, especially if you're new to the investment world.

The Bottom Line

People who invest in stocks can benefit from many different trading strategies. Investors who have more experience and a higher amount of capital at their disposal may be able to ride the market waves and make money using short-term trading techniques. But that may not work for those who are just starting out or aren't able to tolerate too much risk. Holding stocks for the long-term can help you ride the highs and lows of the market and benefit from lower tax rates, and it tends to be less costly.