Following up on Stock Market Indexes 101: Tracking Public Companies, this week we’ll discuss long term investing, a buy and hold investing strategy with a time horizon of more than 10 years.
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Long-term investing describes a strategy that has multiple benefits, including cost savings, tax advantages, and compound interest and is best for an investor with a time horizon of more than 10 years.
It involves buying and holding investments regardless of short-term market fluctuations, prioritizing holding quality investments for the long term.
All companies will have their ups and downs, but strong businesses tend to keep winning over time, and competitive advantages and market opportunities can become even more pronounced and profitable if given time to flourish.
Since its 1957 inception through the end of 2021, the S&P 500 index has returned a historic annualized average return of around 11.88%, demonstrating that the stock market generates returns much more often than it doesn't.
Investing long-term cuts down on costs, helping to reduce related fees and commissions.
Accounts used for long-term investing, such as individual retirement accounts (IRAs) and 401k plans grow tax-deferred, which allows for greater growth over time.
The IRS taxes capital gains based on short-term and long-term holdings. Short-term capital gains of assets sold within a single year of ownership are treated as ordinary income, which means you could be taxed as high as 37% based on your tax bracket. Long-term gains, on the other hand, are subject to a tax from 0% to 20%, depending on your taxable income.
Long-term investors can benefit from compound interest by reinvesting dividends and capital gains, which buy more shares of the investment, while implementing a dollar-cost averaging approach helps to smooth out the ups and downs of short-term volatility.
Knowing when to sell a stock is important even with a long-term approach to investing. Realistically assess your risk tolerance. Invest in companies with meaningful competitive advantages, strong management teams, and viable paths to long-term success.
If you understand a particular sector well and are knowledgeable about the current developments in the space, then it makes sense to invest more of your money in the sector.
Long-term investments should also be part of a diversified portfolio to reduce long-term volatility.
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