How long should you hold a stock? Buffett says if you don’t feel comfortable owning a stock for 10 years, you shouldn’t own it for 10 minutes. The benefit of long term investing in stock market is unparalleled, provided that investments are made in fundamentally strong companies with a good business model, sound management and growth visibility. Staying invested in the market over the long term has historically paid off. Let’s look at these benefits.
Benefits of Long Term Investing
Most of the market participants blow up a huge amount of money in commission, brokerage charges and various taxes by continuous trading in stocks. The more you trade, the more charges are triggered. Long term Investors will save on all these costs as it naturally leads you to transact less often. Every rupee saved can be further added to your investment capital, which makes long term investing very powerful.
Power of compounding:
“Compounding is the eighth wonder of the world. He who understands it earns it. He who doesn’t pays it” – Albert Einstein. The element of compounding comes into play during long term investments when your investments produce earnings through dividends, stock returns etc, they get reinvested in the stock and can earn even more. The more time you’re invested in a stock, the power of compounding gets larger. Your investments can grow exponentially over time.
For example, let’s take two people, Ram and Shyam, who have the same starting balance say Rs 1,00,000 each. They both decide to buy same investment on the exact same day and earn the same interest of 10%. They both plan to hold their investment for 30 years. Ram plans to withdraw the interest at the end of each year, while Shyam plans to reinvest the interest and let it compound. Let’s fast forward 30 years and see the difference in the potential returns. Ram who withdraws the interest, would earn Rs 10,000 per year. Over 30 years, his earnings would have amounted to Rs 3,00,000. But let’s see how much difference reinvesting would have made. As shown in the chart below, Shyam who reinvested the interest would earn, Rs 16,44,940 above his initial balance which is more than 5x of Ram. This example illustrates the power of compounding. Long term investment takes advantage of the power of compounding and maximizes your returns.
Long term investing works because it makes you focus on things that really matter. Long term investors will look at the core fundamentals of the company such as growth prospects, performance, management competency, etc and not look at the day to day fluctuations in stock prices. Over the long term, price movements tend to normalize depending on the performance of the business. Historically, these factors are much effective to predict future returns.
Removes the short term volatility out of the picture:
The stock prices may show very high volatility, i.e, fluctuations in prices in the short term but maybe growing over the long term. These fluctuations tend to confuse the investors as emotions take over leading to rash decisions.
The stock prices never go in one direction continuously without any fluctuations. As you can see in the above chart, there are several upward and downward movements in the price, but looking at the larger picture the stock is trending upwards. Long term investing helps investors ignore these short term fluctuations.
Requires Less time:
Long-term investing requires less of your time. Your work is done when you buy a stock which you think is of high quality and will maintain its competitive advantage over the years. All you have to do is to check periodically whether the company is performing well. Trading and short term investing require one to give full time and efforts to it.
No need to time the markets:
It is very difficult for someone to predict when to enter & exit the market consistently and accurately over various businesses or market cycles. You would be much better off to stay invested in the markets. Investors who try to time the entry and exit points tend to underperform the ones who stay invested throughout.
Fulfilment of long term goals:
Are you saving up to buy a house, fund your retirement or your child’s education? Long term investment is the way to go! To prepare for a high cost future, you should cut down your current costs and invest that money for the long term. The earlier you start, the compounding effect gets larger. You must be thinking which stocks to invest in for such long periods and whether the companies will still have strong fundamentals 5-7 years down the line. StockBasket is a product that will take care of this for you. It is a basket of high quality stocks, carefully chosen by experts. It helps you stay invested for the long term, without worrying about anything else. It keeps track of the portfolio and makes time to time changes if necessary Investors can choose amongst various baskets such as ‘Retirement in 2040’, ‘4x target in 10 years’ depending on their goals and investment horizon.