Many traders would say the ‘glory’ in trading stocks comes from gambling in the market by day trading – running on the adrenaline of picking a few hot stocks and wheeling and dealing for quick, short-term profit.
That form of stock trading may seem glamorous, but it is also a surefire way to lose money unless you’re among the skilled few who can actually make a living day trading.
Most traders who profit from the market and increase their net worth through stocks do so when they buy and hold stocks for the long run. Long-term investing is the main way investors benefit – by finding high-quality companies with strong financials and a firm position in their markets and letting share value increase.
Here, I’ll give you an overview of long-term investing – including what strategies you can employ to increase your chances of finding and keeping a winner.
Long-Term Investing Characteristics
What does it mean to be a long-term investor?
The first hint is to look at how gains from stocks are taxed. If you hold a particular security for less than a year, you pay short-term gains tax, which is your normal income tax rate. If you hold a particular security for more than a year, you are taxed at the long-term gains tax, which is 15% (until 2013; then the rate goes up to 20% in the United States.)
The IRS gives you a tax benefit when you buy and hold stocks for the long term to serve as an incentive for long-term investment. So, one common definition of long-term investing is to buy stocks and hold them for periods of at least one year in length.
Typically, these investors are interested in steadily growing their net worth by letting capital appreciate modestly. Massive gains are nice, but aren’t a requirement; the idea is to pick companies with solid upward trajectories, good cash flows, viable long-term projects and business development, and projected growth.
What type of standard trading strategy – value investing or growth investing – is best suited for long-term investing?
Using Value Investing as a Strategy
Arguably, using a value investing strategy is best for long-term investing for a few reasons.
For starters, value investing is centered on the notion that there are companies who are on solid financial ground, yet for one reason or the other have stock values lower than what they should be. As a result, you can purchase stocks at a discount that could – and should – perform well. Thus, the stock doesn’t have to grow wildly in order for you to turn a good profit; even a modest rate of growth gives you substantial profits.
Also, value investing encourages you to pick a stock and let it grow, rather than trying to time the market (which is virtually impossible to do on a consistent basis for a long period of time). Plus, value investing provides you with a bigger margin for error, since you purchase stocks at a discount.
Good Candidates for Long-Term Investing
What stocks are best for a buy-and-hold philosophy?
Finding value stocks – stocks that trade for less than what their book values suggest they should, or stocks with low P/E ratios and other metrics – is one way to find stocks with potential. You want stocks that have room to appreciate some, although this is by no means the only way to profit. For example, long-term investment also means finding stocks with consistent dividends, and using them to generate steady streams of income.
Blue-chip stocks like Exxon Mobil (XOM), JPMorgan Chase (JPM), DuPont (DD), General Electric (GE), or AT&T (T) may not double or triple in growth over the next few years, but they are big enough and established enough to provide steady dividends while weathering down markets. Many investors turn to these to provide security while generating income and even benefiting from modest capital appreciation.
You can also look for stocks that are undervalued, such as those with low P/E ratios, market values below book value, low price-to-cash-flow ratios, and other metrics. The goal isn’t necessarily to find an average company at discounted prices; it’s to find a good company at a sensible, reasonable price.
Try to avoid “timing the market” or riding trends. Over the long term, a stock market will go up, down, and sideways. Trends will come and go. Prices will fluctuate, and different sectors will become flavors of the month.
Choosing stocks that can be held for the long haul is a way to avoid the uncertainties and stresses of dealing day to day with the market. If you want long-term trading to smooth out volatility, try buying and holding strong stocks from established companies with long-term investments.