The proliferation of zero-commission trading over the past few years has dramatically increased access to the stock market. Theoretically, this is a good thing, as it allows a greater number of Americans the chance to build significant wealth.
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However, it has also resulted in a significant upswing in short-term trading, as traders can move in and out of stocks an unlimited number of times without paying a single commission. Unfortunately, it’s very difficult for a short-term trader to consistently earn — and keep — profits.
Although long-term investing may seem outdated or even “boring” to the new generation of fast money traders, it has historically been a way to build wealth while simultaneously reducing risk. Here are some of the reasons why you should look to 2032 instead of 2023 for investing.
Long-Term Investing Smooths Out the Risk
On a day-to-day basis, the price movements in the stock market can be unsettling. Gains or losses in the overall market of a few percentage points are not uncommon, while drops of 20% or more in individual stocks happen on a regular basis.
This points out one of the significant risks of short-term trading. If you lose 50% on a single position, for example, you don’t need to earn 50% to break even — you need to earn 100%. The reality of this math means that it can be difficult to impossible to recover from just a few big losses in a short-term trading portfolio.
Looking at long-term historical returns of the S&P 500 prove the point in black and white. The simple truth is that there has never been a 20-year period over which the S&P 500 has lost money. That’s an incredible statistic, as it includes everything from the crash of 1929 to the “lost decade” of the 70s, from the dot-com bubble at the start of the millennium to the Great Recession of 2008.
While past performance doesn’t guarantee future returns, this is an amazing record.
Long-Term Investing Still Costs Less
It may seem like you can’t get cheaper than a $0 commission, but there are still costs involved in frequent trading. When you sell stock, you have to pay a small — but non-zero — SEC fee, and over time, this can add up.
In 2022, this fee was raised to 2.3 cents per $1,000 of securities sold. For a zero commission, you’ll also be accepting the risk of a poorer execution. Brokers that charge $0 commissions receive “payment for order flow.” Essentially, this means your broker gets paid to send your order to a specific firm for execution. Whether or not you are always getting the best price available is sometimes hard to determine.
You’ll Pay Less Taxes With Long-Term Investing
If you’re smart or lucky enough to make profits on your short-term trades, you’ll pay for that dearly at tax time. Whereas positions held for longer than one year receive favorable long-term capital gains treatment, those held for one year or less face short-term capital gains rates.
Long-term capital gains rates are 15% for most trades, but could be as low as 0% depending on your income. But short-term capital gains are taxed as ordinary income, meaning you’ll pay the same tax rate as on your wage and salary income. For 2022, this could be as high as 37%, and that’s before state taxes, if applicable.
Index Funds for Long-Term Investing
Berkshire Hathaway CEO Warren Buffett, the “Oracle of Omaha” himself, has long touted the wisdom of investing for the long-term via an S&P 500 index fund. In fact, he has often stated that both large and small investors should stick with low-cost index funds.
Buffett has even instructed the executor of his estate to invest 90% of his money in an S&P 500 index fund after he passes. Many advisors agree, suggesting that regularly adding money to a low-cost index fund is a great way to build long-term wealth.
The Bottom Line
Trading can be exciting, and even profitable for a select few, but in terms of reaching long-term financial goals, it can be risky at best. Experts agree that investing consistently and looking to the long-term is a prudent strategy for the bulk of your portfolio. So set your sights on a decade from now — not mere months.
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