It’s no secret that the stock market has been volatile lately. But despite the roller coaster ride, there’s one group of investors who have been sticking to their strategy and reaping the rewards: long-term holders.
Weathering market volatility
While it’s natural to feel jittery when the markets are in flux, research shows that a long-term investment horizon is one of the best ways to weather market volatility. In fact, a study by Shroders found that over the last century, there hasn’t been a single 20-year period with negative inflation-adjusted returns.
It’s important to remember that market volatility is normal and should be expected. Over the short-term, markets can be notoriously difficult to predict. But over the long-term, they tend to move in predictable patterns.
This is because a longer holding period gives you a better chance of capturing the full market cycle. By staying invested through thick and thin, you’re more likely to buy low and sell high, which is the key to successful investing.
For instance, after a decline of 20% from December 2019 to March 2020 due to the COVID-19 pandemic, the US stock market rebounded and reached new highs. This is just one example, but the findings hold true across time periods and asset classes. A Morningstar analysis of eight market crashes since 1870 clearly highlights that every crash has resulted in a subsequent market recovery.
Taking advantage of compounding
Long-term investing icon Warren Buffet famously quipped, “compound interest is the eighth wonder of the world.” And there’s a good reason for that.
The power of compounding is one of the most important drivers of success for long-term investors. When you reinvest your earnings, you’re able to compound your returns over time, which has a hugely positive effect on your overall performance.
However, pulling money out of the market during volatile periods can have the opposite effect. By selling when the markets are down, you can miss out on the eventual rebound and end up with lower returns.
Selling during a crash has been likened to “catching a falling knife.” It’s often difficult to time the market perfectly, and you can end up getting cut if you sell at the wrong time. A Massachusetts Institute of Technology study revealed that older men are more likely to panic sell during a market crash, but this older demographic is precisely the group that should be staying the course. With fewer years remaining for compounding to work its magic, they can ill-afford to miss out on the market rebound.
Tax benefits
Not only does compounding help you grow your wealth over time, but it can also offer some significant tax advantages.
If you hold an investment for more than 12 months, you’ll qualify for the long-term capital gains tax rate, which is currently 15% for most taxpayers, although it ranges from 0% to 20%, depending on income. This is significantly lower than the short-term capital gains rate of up to 37%.
In addition, if you’re investing in a long-term, qualified retirement account such as a 401(k) or IRA, your money will grow tax-deferred. That means you won’t have to pay taxes on your investment gains until you withdraw the money in retirement. Panic selling before retirement and incurring a hefty tax bill is a mistake that many investors make.
The bottom line
While market volatility can be unnerving, it’s important to remember that it’s a normal part of the investing process. By staying invested and taking advantage of compounding, you can weather the ups and downs and come out ahead in the long run.
Gridline can help. Gridline is a digital wealth platform that provides a curated selection of professionally managed alternative investment funds and enables access for individual investors, and their advisors, to gain diversified exposure to non-public assets with lower capital minimums, lower fees and greater liquidity.
So if you’re looking for a long-term investment strategy that can help you weather market volatility and grow your wealth over time, Gridline is worth a look.