“Follow the yellow brick road, follow the yellow brick…”
You can hear the song in your head, can’t you? Yes, it’s one of the most famous roads in history. But the Yellow Brick Road is also a symbol of hope, optimism, and perseverance — with the promise of something extraordinary at the end of it.
Learn why long-term investing can be your personal Yellow Brick Road when achieving your significant financial goals.
First, What Is Long-Term Investing?
Long-term investing, also called passive investing, follows a “buy and hold” strategy. Essentially, your advisor helps you establish a portfolio to achieve returns over time that align with your more significant goals. It rides out the short-term ups and downs since the focus is on long-term results.
The opposite is short-term investing or active investing. With short-term investing, the goal is to outperform standard benchmarks and achieve the highest returns possible through active and frequent trading.
Reason #1: It Removes Emotions from the Process
One of the most complex parts of short-term investing is that it can force you to make quick decisions. But when it comes to greater health of your financial standings, quick or impulsive decisions aren’t typically the best way to go.
When you enter into an investment to hold it long-term, you’re doing yourself an immense favor by eliminating the need to watch your individual investments.
Why is this significant? Because humans inherently have a fear of regret. We don’t trust our judgment.
This may lead investors to hold onto a stock longer than they should or sell it off as soon as the market shows signs of decline or volatility. These emotionally driven decisions can take a big bite out of your returns — not to mention the transaction costs, fees, and potential tax liability of actively trading often.
Reason #2: Timing the Market Isn’t a Solid Plan
You may have heard the phrase “timing the market” before. It refers to the idea that investors think they can predict when certain investments will gain or lose value. Following these predictions, they sell investments and move those assets to cash before waiting for the market to “crash” and reinvest everything.
The problem with this strategy is that no one can predict the future, and more times than not, investors get it wrong. It’s not a reliable method for investing successfully, and investors can seriously harm their portfolios by following this approach.
Research shows that staying invested through market volatility can generate a better long-term return. A recent study by JP Morgan found that if you chose to sell off stocks and miss the 10 best days of the stock market over the last two decades, your overall return would be cut in half. Even more eye-opening is that six out of the 10 best market days occurred within two weeks of the 10 worst days.1
Many short-term investors don’t remain invested in stocks when a rebound occurs because they’re trying to avoid a loss. They withdraw their funds at the first sign of the market dropping and lock in their losses. When the market inevitably rebounds, they miss the upswing.
By comparison, sticking with a buy-and-hold strategy (aka long-term investing) gives you a better chance of achieving optimal long-term results.
Reason #3: It Helps Lower Your Capital Gains Tax Rate
While you won’t encounter any flying monkeys on this Yellow Brick Road, there’s something else you’ll inevitably come across: taxes.
Profits you earn from selling any capital asset are known as capital gains. This can include hard assets like real estate or investments like stocks and bonds.
If you sell a security within one year of buying it, any gains that the security earned will be taxed as ordinary income. These are short-term gains; the tax is fittingly called short-term capital gains.
Short-term capital gains are something most investors should try to avoid since they’re taxed at the same rate as your AGI. For example, if you’re in the highest tax bracket, your capital gains tax could be up to 37%.
But if you hold onto your securities for more than a year, they’re considered “long-term capital gains.” These gains have a maximum long-term capital gain tax rate of 20%, though they can be as low as 0%, depending on your tax bracket.
Reason #4: Potentially Protects Your Money From the Corrosive Effects of Inflation
Inflation is top-of-mind for many of us, and long-term investments are an excellent option for those looking to shelter funds from it.
Inflation eats away at the value of your money. If you leave your excess funds sitting in a savings account, the value will decrease over time. But by putting what funds you can into an investment account that tracks with or exceeds inflation, you’re preserving your future buying power.
I-bonds are a great option if you want to protect your wealth from inflation while avoiding market volatility or risky investments. These bonds are adjusted for inflation every six months and give investors a fixed rate for that duration.
Excited to Follow the Yellow Brick Road?
If you’re excited and ready to develop a long-term investing plan to grow your nest egg and achieve your important goals, it’s time to work with a knowledgeable financial partner. I specialize in helping clients create custom financial plans and investment strategies based on their unique values, goals, and needs.
Feel free to contact me anytime to learn more about how I can help.
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1Is market timing worth it during periods of intense volatility?