The Advantages of Long-Term Investing over Short-Term Investing

Speaking of the long haul, there are several compelling reasons why investing should always be looked at as a long-term proposition. The first is sheer practicality. Few of us have either the time or the knowledge to be truly active traders if you don’t have the necessary expertise or the time to steer the ship, your Titanic is headed straight for an iceberg (what a night to remember that would be). The second is cost. One thing that Wall Street and other “real-life” movies that address the world of investing (there’s today’s oxymoron) tend to gloss over is that every time you buy or sell something, you pay a commission to someone, somewhere (a commission is essentially a fee you pay to have your investment decision carried out and can run the gamut from dirt cheap to the out-and-out exorbitant). Granted, trading on the Internet has slashed commission costs drastically, but you’re still paying, nonetheless. And, remember, if you’re using a broker to get advice, the commissions can eat into your money stash big time.

The final and most persuasive argument for long-term investing is that, historically speaking, it reduces the risk of what you’re trying to do. Never lose sight of the fact that, with apologies to those who would have you believe otherwise the “wealth without volatility” crowd that, to me, makes as much as sense as, say, “seeing without eyes” successful investing and money growth by definition have to involve risk. To achieve the results that will allow you to reach your goals, you have to acknowledge that things can turn against you. That’s not to say it’s an out-and-out crap shoot, but there is a potential downside to investing you can lose money, often a great deal of it.

The plus side to all of this is that time is your biggest ally in offsetting the risks of investing. The rationale is simple. If you own an investment that drops in value, historical data show that it will recover and actually grow in value, given enough time. For instance, as we pointed out earlier, since 1926 small stocks have increased in value more than 12.5% a year. That’s taking into account several huge one-day stock market drops, one lengthy worldwide depression, several wars, a period when people actually bought rocks as pets, and every other aspect of idiocy the human race saw fit to wallow in. Skeptics will argue that this 72-year period isn’t an ironclad guarantee of what might happen in the future, and they’re right. But it’s a powerful argument in favor of investing for the long haul.

Even a shorter-term perspective shows how time can keep the ups and downs of investing in check. Statistics suggest that, in any given year, mutual funds have a one-third to one-fourth chance of losing money. But if you leave the money in for five years, the chance of losing money drops to 4%; over 10 years, the likelihood of taking a net loss is even less than that. So you can make a fair argument that you’re likely to come out on top even if you don’t leave your money in a fund for a lifetime.

Not only does time tend to smooth out the bumps and bruises investors can experience over the short term, but it also allows compounding to kick in. For those who have heard this term and aren’t really sure what it means, here’s an example. Start with $5 earning 10% a year. At the end of the year, you have $5.50 (your original five, plus 50¢ interest.) The next year, you also earn 10%, but your investment grows by 55¢. That’s because the initial investment, combined with the interest you earned the first year, has grown, so the interest is figured on a larger amount. And this steamrolls on. The longer you let it sit, the more your money earns, the bigger the amount the interest is figured on becomes, and the bigger the return it produces. It’s a marvelous no-brainer. (In fact, there’s a great Seinfeld episode that illustrates this very principle. George tells Jerry about a savings account that he put money into as a kid, then forgot. Turns out, with interest, the account is now worth $1,900, which leads George to declare: “Interest! It’s an amazing thing. You make money by doing nothing!”)