Investing in stocks for the long term can be an effective way to build wealth and achieve your financial goals. While the stock market experiences short-term fluctuations, history has shown that holding stocks over an extended period of time typically leads to growth and positive returns. Patient investors are able to ride out market volatility and take advantage of compounding returns, dividend growth and capital appreciation. Long-term holdings are still subject to a variety of risks, however, including market risk and reinvestment risk. A financial advisor can also help you work long-term holding strategies into your investment portfolio.
What Qualifies as a Long-Term Holding?
A long-term holding in the context of stock investing typically refers to retaining an investment for at least one year but often for much longer. Many long-term investors retain their holdings for five, 10 or even 20 years.
Long-term investors focus on prospects for performance over a prolonged spell of time rather than short-term price fluctuations. By holding onto a stock over a long period, investors aim to benefit from the company's sustained growth and capital appreciation.
In contrast, short-term investing often involves holding a stock for months, weeks, days or even shorter periods of time. The goal is to capitalize on brief market swings or specific events that temporarily affect stock prices.
For example, a day trader might buy a stock at $100 and sell it at $105 within a few hours to take advantage of a quick price increase. A long-term investor, on the other hand, may hold that same stock for 10 years, benefiting from steady price appreciation and dividends over time, even if the stock experiences some ups and downs in the interim. The long-term strategy requires patience but can result in greater wealth accumulation over time.
5 Benefits of Holding Stocks for the Long Term
Holding stocks for the long term can offer a variety of advantages that can help you build wealth over time. Here are five general benefits:
- Compound growth: One of the most powerful benefits of long-term investing is compound growth. When you reinvest your earnings, such as dividends or capital gains, your investment grows at an accelerated rate. Over time, this compounding effect can significantly increase the value of your portfolio, especially when held over decades. The earlier you start investing, the more time your money has to compound, which can lead to substantial growth.
- Reduced impact of market volatility: The stock market is subject to short-term volatility, with prices fluctuating due to various factors like economic conditions, political events or investor sentiment. While volatility can be unsettling, over the long term these fluctuations tend to smooth out. Most importantly, the overall trend is upward. If you wait long enough, the broad market always recovers. By holding onto stocks for a longer period, you're less affected by day-to-day price changes and more likely to benefit from the market's long-term growth.
- Tax advantages: Holding stocks for the long term also comes with tax benefits. In the U.S., investments held for over a year are subject to the long-term capital gains tax rate, which is typically lower than the short-term capital gains rate applied to assets held for less than a year. This lower tax rate can make a significant difference in your net returns, especially if you're selling a large position.
- Dividend growth: Many long-term investors benefit from dividend-paying stocks. Over time, companies that regularly pay dividends often increase the size of their payments, which can provide a steady income stream. Reinvesting these dividends allows you to purchase more shares, compounding your returns. This makes dividend-paying stocks particularly attractive for long-term investors.
- Potential for capital appreciation: As companies grow and become more profitable, their stock prices tend to rise. By holding a stock over a long period, you can benefit from this capital appreciation. Successful long-term investments in well-performing companies can lead to substantial increases in the value of your portfolio, even if the stock price experiences occasional dips along the way.
What Makes a Stock a Good Long-Term Investment?
When choosing stocks for long-term investment, it's important to look for companies that have strong fundamentals and the potential for sustained growth. Here are five factors to consider:
- Strong financials: A company with solid financials is more likely to perform well over the long term. Look for companies with good revenue growth, healthy profit margins, manageable debt levels and consistent cash flow. A solid financial foundation suggests the company can weather economic downturns and continue to grow over time.
- Competitive advantage: A company with a competitive advantage – such as a well-established brand, proprietary technology or a large market share – has a better chance of maintaining profitability over the years. Companies that dominate an industry or have unique offerings are more likely to deliver long-term growth.
- Consistent earnings growth: Consistent earnings growth is a good indicator of a company's long-term potential. Look for businesses that have steadily increased their earnings over time, as this suggests the company is managed well and has room to continue expanding.
- Dividend payouts and growth: For long-term investors seeking income, stocks that regularly pay dividends are worth considering. Companies with a history of increasing their dividend payouts can provide reliable income while also offering the potential for capital appreciation.
- Industry trends and market potential: It's also important to consider broader industry trends and the market potential of the company's sector. Investing in industries that are expected to grow, such as technology or healthcare, can provide opportunities for long-term gains as demand for these products and services increases over time.
Long-Term Investing Risks
While long-term investing has many advantages, it also comes with risks. Among them is market risk. This could arise if the market enters an extended downturn during which you have to sell long-term investments at a loss.
Other risks include operational risk, which is the risk that a company will perform poorly due to internal or external factors and your shares will lose value or even, potentially, become worthless. Liquidity risk, which is the risk that you won't be able to quickly sell your investments at a favorable price when you need to, can also be a factor. Reinvestment risk, which is the risk that you won't be able to reinvest funds later on in an investment with appealing returns, is another possibility.
Bottom Line
Holding stocks for the long term can be an effective way to grow your wealth and achieve financial goals. By taking advantage of compound growth, benefiting from tax advantages and riding out market volatility, long-term investors can see significant returns on their investments. Choosing stocks with strong financials, competitive advantages and growth potential can increase your chances of success.
Investment Planning Tips
- Whether you're investing long-term or short-term, a financial advisor could help you determine which type of account or investment will fit your needs. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much your investment could grow over time, SmartAsset's investment calculator could help you get an estimate.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
