As long as markets have existed, many investors have tried to maximize gains and minimize losses by timing the market.
In theory, investors believe they should buy when prices are low but rising and sell when prices are high but falling. However, to time the market perfectly, you have to be successful twice: once when you buy and then again when you sell. Getting the timing right on both ends is doubly difficult. Plus, every time you trade, you incur costs such as brokerage fees and taxes, which can quickly reduce any additional returns you’ve gained on both the purchase and the sale.
Instead of trying to time the market, consider spending time in the market using a buy-and-hold strategy, where you buy stocks and other securities and hold on to them regardless of market fluctuations. Following are a few reasons you may want to explore implementing this long-term investing strategy.
1. Investments can grow despite market fluctuations
The U.S. stock market volatility can be intimidating — but history shows the market has been able to recover from declines and still provide investors with a positive return on long-term investments. In fact, over the past 35 years, the market has posted a positive annual return in nearly eight out of every 10 years.1
2. Participate in the market’s biggest days
A buy-and-hold strategy can help investors avoid missing out on the market’s biggest days.
The hardest part about choosing when to be in or out of the market is that missing a few key days or weeks of a five- or ten-year cycle can have a significant influence on your returns. Historically, a large share of the stock market’s gains and losses occur in just a few days of any given year. Since the pattern of returns isn’t predictable from month to month, a consistent investment can add to your bottom line.
3. Recoup losses faster
For most investors, a buy-and-hold strategy can result in quicker loss recuperation, even after a bear market when a major index like the S&P 500 falls by more than 20% from its recent high.
As an example, let’s say you invested $1,000 in the S&P 500 on January 1, 2008. That year, the S&P 500 lost 37% of its value.2 At the end of 2008, your investment was worth $630. Consider the differing outcomes depending on whether you used a buy-and-hold strategy or chose to reinvest $630 into a savings account with a 3% interest rate, compounded monthly.
Using a buy-and-hold strategy, you would have recouped your losses by 2012, even without making additions to your original investment. With your funds in the savings account, in this example, it would take 16 years to recoup your losses and cross the $1,000 threshold.
4. Grow with compound interest
A buy-and-hold strategy can also help investors take advantage of compound interest. While past performance is not a guarantee of future returns, the S&P 500’s inflation-adjusted average annual return is about 7%.3 This means, on average, the index’s value is 7% higher at the end of the year than it was at the beginning. These gains accumulate over time and can provide an advantage to those who start investing early.
5. An early start could mean more dividends
Investors often try to wait for the “right” time to start putting money into the stock market. But the longer they delay their investing, the longer they’re missing out on company dividends.
Dividends are not to be underestimated. These individual payouts might seem small, especially when you’ve been investing for only a few years, but more than 40% of the historical gains in the S&P 500 have come from dividends.2
As an investor, you can choose to cash in your dividends as soon as they’re available, or you can opt to reinvest your dividends back into the market, manually or automatically.
Historically, a large share of the stock market’s gains and losses occur in just a few days of any given year. Since the pattern of returns isn’t predictable from month to month, a consistent investment can add to your bottom line.
Automatic dividend reinvestment expands your portfolio with minimal effort on your part. As you reinvest your dividend payouts, you’ll purchase additional shares that earn additional dividends. In other words, dividend reinvestment can help you leverage the magic of compound returns. Accumulating dividends can add significant value to your portfolio.
Still, it’s important to understand two potential downsides to automatic dividend reinvestment.
- The dividends you receive from Company A are automatically reinvested to purchase more shares of Company A. This takes away your option to reinvest dividend payouts from Company A into Company B, even if Company B is more attractive and would accelerate your portfolio’s growth.
- If you automatically reinvest dividends, you still need to account for taxes. When you receive a dividend payment, that amount of the dividend is taxable income, even if the dividends were reinvested into the same stock automatically.
If you’re investing for retirement, you might want to turn off dividend reinvestment once you’ve stopped working. That way, you’ll receive cash distributions that you can put toward living expenses. Before retirement, however, reinvesting dividends can help maximize your gains and set you up for the potential to receive higher payouts later on.
6. Get started through lump sum investing or dollar cost averaging
There are generally two buy-and-hold investing options. You can choose to buy your investments all at once (lump sum investing) or begin an investment schedule (dollar cost averaging).
- Lump sum investing is exactly what it sounds like. If you have a lump sum to invest, you can invest it all at once. A lump sum approach requires you to have a larger sum of money to invest. You may receive a lump sum of cash through the sale of a family business, sale of company stock, inheritance, proceeds from an insurance policy, or by other means.
The sooner you invest your sum of money, the sooner you begin earning returns, especially, in this case, compound returns.
- Dollar cost averaging is the practice of contributing a fixed dollar amount into an investment on a regular schedule. It allows you to enter the market even if you have only a small amount to invest each month.
As an example, let’s say you invest $300 per month for one year in an index fund that covers a broad range of stocks. When values — the prices you pay for your shares — are higher, your $300 contribution will purchase fewer shares. When values are lower, your contribution will purchase more shares. Over the course of a year, you’ll most likely pay an average price for the investment overall. Therefore, you’ve reduced the risk of repeatedly buying at peak values.
With this approach, you can start investing early and take advantage of compound returns. It’s important to note that dollar cost averaging does not guarantee you’ll pay less for your investments compared with a one-time buy. But investing on a regular schedule helps develop a habit of putting money away. Plus, you can set up automatic contributions to make regular investments.
Oftentimes, emotions can sabotage a buy-and-hold, long-term investment strategy. Overconfidence might lead you to trade too frequently while fear of loss might cause you to hang on to investments that no longer support your goals or earn a sustainable return. However, when you invest more regularly and focus on the long-term, you can feel confident that you’re steadily working toward your goals.
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