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RIIQ Newsletter

Good morning investors!

If this is your first time reading, welcome to Raising InvestorIQ!

Every Sunday morning, we publish a free write-up within our RIIQ Newsletter with leading insight and analysis — the aim is to help investors of all skill levels focus on key fundamentals, gain confidence in developing an investment strategy, and gain an edge in the push to generate true wealth.

Grab your coffee and let’s dive in!

What You’ll Learn Today

• Key advantages of investing for the long-term

• A case-study regarding a risky, short-term investment strategy

• Why long-term investing aids with minimizing taxes and transaction costs

• Vital aspects of Warren Buffett’s core investing principles

• How to help manage the ups and downs of market volatility

Time is the Investor’s Best Friend

The longer you stay invested, the more compounding works in your favor

Intro

"If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."

Warren Buffett

Warren Buffett, the Oracle of Omaha, has always championed a long-term view when it comes to investing. His famous words, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes,” encapsulate his philosophy that patience and resilience are critical to financial success.

In this RIIQ Key Investment Insight, we’ll explore why long-term investing is a proven path to wealth, how it contrasts with short-term trading, and why Buffett’s approach is one that more investors should adopt.

The Power of Compounding Returns

The bedrock of long-term investing success lies in compounding returns. Compounding is the process where the earnings on your investments generate their own earnings, leading to exponential growth over time.

This is particularly powerful in stocks, where both price appreciation and dividends reinvested add to your portfolio’s value. As Buffett has frequently pointed out, time is the investor’s best friend, and the longer you stay invested, the more compounding works in your favor.

To illustrate, let’s say you invest $10,000 in a stock that earns an average of 7% annually. Over 20 years, this initial amount would grow to more than $38,000 thanks to compounding, without you needing to lift a finger (see graph below, the compounding exponential effect).

This growth accelerates even further if dividends are reinvested, a practice Buffett advocates for maximizing returns. For traders, the focus on short-term gains means they often miss out on this powerful wealth-building tool. By constantly buying and selling assets in search of quick profits, traders sacrifice the compounded growth that long-term investors enjoy. Compounding, after all, requires time, and those who sell too soon cut short this incredible force.

Minimizing Taxes and Transaction Costs

One major reason why Warren Buffett favors a long-term approach is the tax efficiency it provides. In most markets, including the U.S., gains on investments held for over a year are subject to long-term capital gains tax, which is significantly lower than the tax on short-term profits. For example, short-term gains can be taxed at rates as high as 37%, while long-term gains are taxed at 0%, 15%, or 20%, depending on your income bracket.

Traders, by contrast, are taxed at much higher rates because their profits come from short-term capital gains, which are treated as ordinary income. This not only eats into their profits but also adds administrative complexity, as frequent trading means constant tax reporting.

But it doesn’t stop at taxes. Frequent buying and selling also leads to higher transaction costs. Even in the era of zero-commission trading, traders face hidden fees such as spreads and slippage, where the actual price paid for a stock is different from the quoted price. These costs add up over time, especially for day traders who make numerous transactions.

Long-term investors, on the other hand, benefit from reduced transaction costs, as well as reduced taxes. Since they buy and hold assets for years, they don’t incur frequent fees. Plus, by holding on to stocks, they allow their investments to grow without constant interruption, saving both money and time in the process.

Long-Term Investing: Riding Out Market Volatility

Another key advantage of long-term investing is its ability to smooth out market volatility. Markets are unpredictable in the short term. A company might release bad news, sending its stock price tumbling, or global events like geopolitical tensions can cause widespread sell-offs. Traders are highly susceptible to these fluctuations, often losing money by panic selling when prices drop unexpectedly.

Long-term investors, however, don’t have to worry as much about these short-term swings. Instead, they focus on the underlying intrinsic value of the companies they invest in. If they’ve chosen wisely, with solid companies that have strong fundamentals, they know that the market will eventually correct itself and that stock prices will rise again over time.

A perfect example of this is Amazon (AMZN). Investors who bought Amazon stock in the early 2000s had to endure several sharp drops in the company’s stock price, including a dip during the 2008 financial crisis. But those who stayed the course were rewarded handsomely.

Over two decades, Amazon's stock price increased by more than 500%, turning early investments into small fortunes. For traders, it would have been nearly impossible to time these price movements, but for long-term investors, patience paid off in spades.

Warren Buffett has always been a master of this approach. His investment strategy focuses on buying companies with strong competitive advantages and holding onto them for decades. Take Coca-Cola, for example, one of Buffett’s most famous investments. Despite various market dips over the years, Buffett has held on to Coca-Cola for over 30 years, benefiting from both the company’s growth and its reliable dividends.

The Dangers of Short-Term Trading

Short-term trading is often portrayed as glamorous and exciting. Traders aim to profit from small price movements by buying and selling frequently, sometimes within minutes or hours. The allure of quick profits draws many people into day trading or swing trading. However, what is often overlooked is just how risky and difficult trading can be.

Trading requires constant attention to the markets. Traders must spend hours every day analyzing charts, indicators, and news to identify the right times to buy and sell. Even then, no amount of technical analysis can predict sudden market moves caused by external factors. A stock’s price might plummet due to a CEO’s resignation or a geopolitical event, causing traders to lose money in the blink of an eye.

Moreover, many traders use leverage, borrowing money to increase the size of their trades. While this can amplify profits, it can just as easily magnify losses. If a trade goes wrong, leveraged traders can lose far more than they initially invested, leading to devastating financial consequences. The rapid pace and high risk of trading make it a dangerous game, and statistics show that most retail traders end up losing money.

In contrast, long-term investors take a more relaxed approach. Instead of obsessing over daily price movements, they focus on the big picture—the overall health of the companies they invest in. By doing so, they avoid the stress, risk, and frequent losses that plague traders. It's less tiring and in the end seems to pay off better!

Warren Buffett’s Investment Principles

Buffett’s long-term success is no accident. He follows a few core principles that guide his investments, and these can serve as valuable lessons for any investor looking to build wealth over time:

• Buy what you understand: Buffett only invests in companies whose business models he fully understands. This allows him to make informed decisions and hold on to his investments even when the market turns volatile.

  It’s a simple rule: if you don’t understand how a company makes money, it’s probably not a good idea to invest in it.

• Look for intrinsic value: Rather than getting caught up in stock prices, Buffett focuses on the intrinsic value of a company. This is the actual worth of the business, based on its earnings, assets, and future growth potential.

  By investing in companies with strong fundamentals, Buffett ensures that his investments will grow over time, regardless of short-term market noise.

• Be patient: Buffett is perhaps the ultimate advocate for patience. He famously said, “The stock market is designed to transfer money from the Active to the Patient.” Instead of chasing quick profits, Buffett is content to let his investments mature over years or even decades, reaping the rewards of compounding and market growth.

Case Study: Credit Suisse and Shorting Risks

Let’s compare Buffett’s strategy with a more short-term example—Credit Suisse.

Over the past decade, Credit Suisse has seen its stock price collapse due to a series of scandals and financial troubles. Investors who bought the stock and held it long term have suffered significant losses, with the share price dropping by over 86%.

However, traders who were able to short Credit Suisse stock—betting on its price decline—could have made a profit. Shorting is a strategy where traders borrow shares, sell them at the current price, and buy them back later at a lower price. But while shorting can be profitable, it’s also incredibly risky. If the price of the stock unexpectedly rises, traders can face unlimited losses. This is the opposite of what happens when you buy a stock, where the maximum loss is limited to your initial investment.

For most retail investors, shorting is too risky, and the example of Credit Suisse highlights how quickly things can go wrong. In contrast, Buffett’s long-term approach avoids these speculative risks by focusing on companies with solid fundamentals.

Conclusion: Why Long-Term Investing Wins

In the battle between trading and long-term investing, it’s clear that long-term investing offers the best path to sustainable wealth. 

The power of compounding, lower taxes, reduced transaction costs, and the ability to ride out market volatility make it the smarter choice for most investors. Warren Buffett’s career serves as a shining example of how patience, discipline, and a focus on fundamentals can lead to extraordinary financial success.

For those looking to build wealth over time, the message is simple: invest in quality companies, hold on to them for the long term, and let time work its magic. After all, as Buffett wisely said, “The stock market is a device for transferring money from the impatient to the patient.”

Learn How To Double Your Money Every 7 Years

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Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP.

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