Many market experts suggest holding stocks for the long term. The Standard & Poor's (S&P) 500 Index has experienced losses in 10 of the 40 years from 1975 to 2015, making stock market returns quite volatile in shorter time frames. However, investors have historically experienced a much higher rate of success over the longer term.
In an ultra-low interest rate environment, investors may be tempted to dabble in stocks to boost short-term returns, but it makes more sense to hold on to stocks for the long term.
Better Long-Term Returns
An examination of several decades of historical asset class returns shows that stocks have outperformed most other asset classes. Using the 87-year period from 1928 to 2015, the S&P 500 has returned an average of 9.5% per year. This compares favorably to the 3.5% return of three-month Treasury bills and the 5% return of 10-year Treasury notes.
While the stock market has outperformed other types of securities, riskier equity classes have historically delivered higher returns than their more conservative counterparts. Emerging markets have some of the highest return potential in the equity markets, but also carry the highest degree of risk. Short-term fluctuations can be significant, but this class has historically earned 12 to 13% average annual returns.
Small caps have also delivered above-average returns. Conversely, large-cap stocks have been on the lower end of returns, averaging roughly 9% per year.
Opportunity to Ride Out Highs and Lows
Stocks are considered to be long-term investments. This is partially because it's not unusual for stocks to drop 10 to 20% or more in value over a shorter period of time. Over a period of many years or even decades, investors have the opportunity to ride out some of these highs and lows to generate a better long-term return.
Looking back at stock market returns since the 1920s, individuals have never lost money investing in the S&P 500 for a 20-year time period. Even considering setbacks like the Great Depression, Black Monday, the tech bubble and the financial crisis, investors would have experienced gains had they made an investment in the S&P 500 and held it uninterrupted for 20 years. While past results are no guarantee of future returns, it does suggest that long-term investing in stocks generally yields positive results, if given enough time.
Investors Are Poor Market Timers
One of the inherent flaws in investor behavior is the tendency to be emotional. Many individuals claim to be long-term investors up until the stock market begins falling, which is when they tend to withdraw money for fear of additional losses. Many of these same investors fail to be invested in stocks when a rebound occurs, and jump back in only when most of the gains have already been achieved. This type of "buy high, sell low" behavior tends to cripple investor returns.
According to Dalbar's 2015 Quantitative Analysis of Investor Behavior study, the S&P 500 had an average annual return of roughly 10% during the 20-year period ending Dec. 31, 2014. During the same time frame, the average investor experienced an average annual return of just 2.5%. Investors who pay too much attention to the stock market tend to handicap their chances of success by trying to time the market too frequently. A simple long-term buy-and-hold strategy would have yielded far better results.
Lower Capital Gains Tax Rate
An investor who sells a security within one calendar year of buying it gets any gains taxed as ordinary income. Depending on the individual's adjusted gross income, this tax rate could be as high as 39.6%. Those securities sold that have been held for longer than one year see any gains taxed at a maximum rate of just 20%. Investors in lower tax brackets may even qualify for a 0% long-term capital gains tax rate.