long term investing
There are several key benefits for using long term investing for your retirement planning:
1. Compounding Returns
One of the biggest advantages of long term investing is the power of compounding returns.
When you reinvest the returns from your investments, those returns start earning additional returns themselves over time.
This compounding effect can significantly boost your overall returns, especially when investing over decades for retirement.
The longer you stay invested, the more powerful compounding becomes.
The Mechanics of Compounding
When you invest money and earn a return (e.g. interest, dividends, capital gains), that return gets reinvested and added to your principal investment amount.
From that point on, future returns are earned on the new higher total balance.
This cycle continues, with returns earning returns on top of the original investment, leading to exponential growth over long periods.
For example, if you invest $10,000 at a 7% annual return:
- Year 1: $10,000 + (7% of $10,000) = $10,700
- Year 2: $10,700 + (7% of $10,700) = $11,449
- Year 3: $11,449 + (7% of $11,449) = $12,250
Notice how the dollar returns get larger each year as the principal grows.
The Power of Time
The earlier you start investing, the more powerful the compounding effect becomes over decades. This is because your returns have more time to compound upon themselves.
For example, if you invest $5,000 per year for 30 years at 7% returns:
- If you start at age 25, you’ll have $662,399 at age 65
- If you start at age 35, you’ll have $368,612 at age 65
- If you start at age 45, you’ll have $160,921 at age 65
The 10-year head start from age 25 to 35 results in almost double the final amount!
2. Riding Out Market Volatility
While markets experience short term fluctuations, long-term investors can ride out the volatility by staying invested through the ups and downs.
Historically, equity markets have recovered from downturns and provided positive returns over longer time horizons.
A long-term investment approach allows you to avoid the pitfalls of trying to time the market.
One pitfall is panic selling after a downturn.
This guarantees losses or smaller gains in your investments.
But, if you have a long term view on your investments, you can ignore the noise of day-to-day or month-to-month market conditions.
5 years later or 20 years later, those short-term downturns will have been forgotten.
3. Potential for Higher Returns
Investments like stocks have historically provided higher returns than more conservative assets like bonds or cash over the long run, though with higher risk.
By having a long investment horizon, you can take advantage of the increased growth potential of equities while weathering their short-term volatility.
With long-term investing, you can ride through ups and downs and volatility in order to achieve better returns in the long run.
4. Benefiting from Dollar-Cost Averaging
With long-term investing through regular contributions (e.g. in a 401(k) or IRA), you automatically practice dollar-cost averaging.
You buy more shares when prices are low and fewer when prices are high. This strategy can lower your overall cost basis and boost long-term returns.
The way it works is that no matter what, every week or every month, you put in the same fixed amount into your investments.
So let’s say this is $500 per month after you receive your paycheck.
This goes in regardless of what is happening in the overall macro environment.
This takes away the worry of when to invest and keeps you on a schedule to do it automatically.
5. Adjusting for Changing Risk Tolerance
As you approach retirement, you can gradually shift your asset allocation to lower-risk investments like blue chip dividend stocks or bonds.
This protects the wealth you’ve built while still allowing growth potential.
It is important to consider your time horizon.
Your investment time horizon shrinks as you get closer to retirement age.
With less time to recover from market downturns, it makes sense to take a more conservative approach and prioritize capital preservation over higher potential returns from riskier assets.
Rebalance over time.
The key is making gradual adjustments rather than drastic changes.
Reducing risk too quickly can sacrifice growth potential you may still need.
Adjust slowly in a way that provides enough growth for your needs while mitigating volatility based on your decreasing risk tolerance.
6. Tax-Advantaged Accounts
Tax-advantaged accounts are special types of investment accounts that offer tax benefits to encourage saving for specific goals like retirement, education, or healthcare expenses.
Retirement accounts like 401(k)s and IRAs provide tax-advantaged ways to grow your investments over decades.
This allows more of your returns to compound tax-deferred (or tax-free for Roth accounts).
Plan for your future
In Summary
The key benefits of long-term investing for retirement are harnessing compounding returns, weathering volatility, pursuing higher growth potential, benefiting from dollar-cost averaging, adjusting risk over time, and utilizing tax-advantaged accounts.
A disciplined long-term approach can significantly increase your retirement savings.
