You have probably heard the phrase “invest for the long term” many times. But what does it mean? And why is it essential for your financial future?
Long-term investment is the process of buying and holding assets for more than one year, expecting higher returns over time. Long-term investment options include stocks, bonds, real estate, mutual funds, and more.
Long-term investing has many benefits that can help you achieve your bigger life goals. Let’s look at the benefits in detail and see how they can make a difference in your wealth creation.
Long-Term Investment Benefits
1. Cost-effectiveness
One of the advantages of long-term investing is that it can save you a lot of money on commission, brokerage, and taxes. You incur These expenses every time you buy or sell an asset. The more frequently you trade, the more you pay.
For example, you buy 100 company shares at Rs. 100 per share and sell them after a month at Rs. 110 per share. You make a profit of Rs. 1,000, but you also pay a commission of Rs 100 and a short-term capital gains tax of 15%, which is Rs. 150. So your net profit is only Rs. 750.
Let’s say you buy the same 100 shares at Rs. 100 per share but hold them for a year. The price goes up to Rs. 150 per share, and you sell them. You make a profit of Rs. 5,000, but you pay a commission of Rs. 100 and a long-term capital gains tax of 10%, which is Rs. 500. So your net profit is Rs. 4,400.
This is an example of stocks, but if you buy an online term plan for a longer period and buy at an early age, the premiums will be much more affordable. If you are thinking what is term plan, then it is a simple life insurance that pays a lump sum if you pass away during the chosen term. It ensures financial security for your family.
Compounding returns
Compounding is reinvesting your earnings back into your investment so that they can generate more profits in the future.
For example, let’s say you invest Rs. 10,000 in one of the mutual fund schemes with a 10% annual return. After one year, you will have Rs. 11,000. If you withdraw your earnings of Rs. 1,000, you will have the same Rs 10,000 invested for the next year. But if you reinvest your earnings, you will have Rs. 11,000 invested for the next year. This means you will earn 10% on Rs. 11,000, which is Rs. 1,100, instead of Rs. 1,000. This way, your investment will grow faster and faster over time.
The formula for calculating the future value of an investment with compounding is:
FV = PV * (1 + r)^n
Where:
– FV = Future Value
– PV = Present Value
– r = Annual Interest Rate
– n = Number of Years
Using this formula, you can see how much your investment will be worth after a certain period. For example, if you invest Rs. 10,000 for 10 years at a 10% interest rate, your future value will be:
FV = 10,000 * (1 + 0.1)^10
FV = 25,937.42
This means that your investment will more than double in 10 years, thanks to compounding.
Tax efficiency
A third benefit of long-term investing is that it can help you enjoy lower tax rates on your capital gains than short-term investors. Capital gains are the profits you make when you redeem your investment for a higher price than you bought it. Dividends are the payments that you receive from a company as a shareholder.
The current tax rates for long-term and short-term investments in India are as follows:
- Long-term capital gains tax of 10% on profits surpassing Rs. 1 lakh in a financial year for assets held for more than one year
- Short-term capital gains tax of 15% on gains for assets held for less than one year
Other benefits
Apart from the above benefits, long-term investing also has some other advantages, such as:
- Reduced volatility: Volatility is the degree of fluctuation in the price of an asset over time. High volatility means the price can alter significantly quickly, which can be risky and stressful for investors. Long-term investors are less affected by the short-term fluctuations in the market and can focus on their investments’ long-term performance and potential.
- Higher returns: Long-term investors can benefit from the historical trend of the market, which shows that the market tends to go up in the long run despite the occasional downturns and corrections. Long-term investors can also capture the growth and value of the companies they invest in, as they can benefit from increased earnings, dividends, and market share over time.
Conclusion
Long-term investing is an innovative and effective way to build wealth and achieve bigger life goals. By investing for the long term, you can enjoy the benefits of cost-effectiveness, compounding returns, tax efficiency, reduced volatility, higher returns, and better diversification.
However, long-term investing is not a one-size-fits-all strategy. You must choose the best investment options based on your ambitions, risk appetite, and time boundary. You must also track your portfolio regularly and adjust it according to changing market and personal circumstances.