Why Do Investors Hold A Long Position?
If you contribute to a retirement account, you’re engaged in a long position. Long positions are trades or investments held with the expectation that they’ll appreciate in value over a long enough period of time. The goal is to ride price appreciation higher and higher, until it reaches a peak or the time horizon of the investment comes to a close. In any case, investors expect to walk away with accumulated wealth.
The length of this position depends on the investment thesis. Generally, any investment held over a year is a long position—at least, in the eyes of the IRS. Positions sold earlier than a year are subject to a higher tax rate than those that existed after a year. However, long positions can span decades. For example, a dividend investor may jump into a DRIP plan and hold a pool of healthy dividend stocks for 30, 40 or even 50 years.
Investors have different theses behind their long positions, but every investor hopes for the same result: significant return on investment, using time as a wealth accelerator.
Long Position vs. Short Position
Before delving into the benefits of long positions, it’s important to juxtapose them against short positions. Where a long position is any position held for longer than a year, short positions actually have two definitions. A short position is any position held for less than a year or a bet on poor performance from a company.
- A day trader may take a position in ABC Company with the intent to sell it before the closing bell. This action represents a short-term outlook on the position.
- An investor may see a negative outlook for XYZ Company and take out a short position in the stock, betting on it to fall below a certain support level.
In either case, a short position is one that sees only immediate value in a company—usually at the expense of that company. Conversely, a long position shows confidence in the company’s growth and success over an extended period of time. Long positions are a believe that the value of the stock will rise.
Going Long is Easier Than Shorting
Most regular investors find themselves long in positions simply because that’s the default mode of investment. People want to invest in stocks and assets that will appreciate with time! So long as the holding is worth more than the original price paid, the investor is long.
Shorting stocks is more complex, and exposes investors to more risk. The process involves borrowing shares, selling them, then buying them back when the price drops. And while there are ways to protect yourself in a short position, the risk and complexity is something many investors shy away from. It’s simply easier and less intimidating to bet on an investment you feel will outperform the market—as opposed to betting on the underperformance of a company in the near-term. Moreover, short positions come with a timeframe; investors can hold for as long as they want.
The Power of Compound Interest
Also called the Eighth Wonder of the World by Albert Einstein, compound interest is a powerful force for generating wealth. For long positions, it’s the key to prolific accumulation. The longer an investor holds a position, the more compounding periods it benefits from. Take a look at what happens to a single investment of $5,000 over a 30-year stretch of time, given no additional contributions and an appreciation rate of 8%:
- After one year, the value of the investment is $5,415
- Five years, the value of the investment is $7,449
- 10 years, the value of the investment is $11,097
- 15 years, the value of the investment is $16, 532
- 20 years, the value of the investment is $24, 630
- 30 years, the value of the investment is $54,670
This position takes full advantage of a stock’s propensity to rise and the many compounding periods it sees over time. Long positions allow investors to sit back while time in the market does the work for them.
Tax Advantages to Long-Held Positions
In addition to compounding wealth, long positions also benefit from more generous tax treatment—in a number of ways.
The IRS taxes short-term gains differently from long-term gains, with the latter seeing an effective tax rate that’s lower than the former. While it depends on the investor’s tax bracket and income, long-term capital gains are invariably held to a lower tax rate than short-term.
Long positions held within retirement accounts are also tax advantaged. Investors either see tax-deferred growth or tax-free growth, depending on whether they have a traditional or Roth investment account. Long positions in qualified retirement vehicles such as a 401(k) or IRA have a built-in safeguard against capital gains tax.
Time is an Ally for Long-Term Investors
The catalyst for success in this position is time. Where traders see time as a volatile element that perpetuates risk, investors in long positions see it as the gateway to accumulation. Over a long enough time horizon, the stock market as a whole always goes up. Enough time in a position soothes the ebbs and flows and mitigates volatility. For most long-term investors, it’s not if the market will return value; it’s how much value it’ll return while the position is open.
This strategy can be extremely beneficial for retirees and other individuals closing in on retirement. To learn more, sign up for the Wealthy Retirement e-letter below.
Combine compound interest with tax benefits for long-term investments and it lays the groundwork for smart, stable investments that perform as-intended. And while long positions are more illiquid than short-term investments, their ROI is often worth the wait.