This Rookie Mistake Could Cost You Thousands | Smart Change: Personal Finance


(Stefon Walters)

Stock market corrections – defined by declines between 10% and 20% in the main indices – are inevitable in the stock market. In fact, they usually occur at least once every two years on average. If you are an investor, you will save yourself some stress by accepting that fact. The only thing you definitely want to avoid is to panic. Not only can it be expensive right now, but it can also cost you a lot of money in the future.

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Let time do its magic

One of the main concepts of investment is compound interest. Albert Einstein himself allegedly called it the “eighth wonder of the world.” Compound interest occurs when the money you earn from your investments begins to make money in itself. But for compound interest to really do its magic, it takes time. If you made a single $ 10,000 investment in an asset that returned 10% per annum, you would accumulate $ 108,000 in 25 years.

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When things get tough on the stock market and prices start to go down, some people panic and sell their shares because they are afraid of losing more money. However, for long-term investors, panic selling is one of the last things you want to do, because it takes away the power of compound interest.

Imagine that, for the past 10 years, you have been contributing $ 6,000 a year to a Roth IRA (the maximum for people under the age of 50), and those stakes returned 10% a year. In those 10 years, you would accumulate more than $ 105,000, even if you only contributed $ 60,000 in person. Regardless of what happens in the market, taking out that $ 105,000 would probably be a mistake.

If you kept your contributions for another 10 years, you would invest an additional $ 60,000, but the total value of your account would exceed $ 378,000 by the end of the second decade (assuming the same 10% rate of return). If he had left the market, he would have interrupted the powerful effect that compound interest has on his portfolio.

Even if he exhausted his investments for only one year, for example, in the year 16, before reinvesting them for the rest of the decade, his holdings would amount to only $ 346,000. In other words, even though he still made all the annual contributions of $ 6,000, that year of discount reduced his return by more than $ 30,000.

Don’t forget Uncle Sam

Another reason you want to avoid panic sales during stock market corrections or falls is because it could be more expensive than you imagine once you consider the tax consequences. For a standard brokerage account, if you have held investments for less than a year, the proceeds of the sale are taxed at your ordinary income tax rate. For the unique presenters in 2022, the brackets are:

Income range Tax percentage
$ 0 to $ 10,275 10%
$ 10,275 to $ 41,775 12%
$ 41,775 to $ 89,075 22%
$ 89,075 to $ 170,050 24%
$ 170,050 to $ 215,950 32%
$ 215,950 to $ 539,900 35%
$ 539,900 or more 37%

If you have held the investment for a year or more, you will benefit from the capital gain rate:

Income range Long-term capital gains tax rate
$ 0 to $ 40,400 0%
$ 40,401 to $ 445,850 15%
$ 445,851 or more 20%

Although the rate of capital gains is more favorable than the usual rate of income tax, it is still money you owe. If you sell in response to short-term volatility, you will also need to consider how much it will cost you in taxes. Paying 15% on a $ 100,000 capital gain is not only $ 15,000 with your next tax bill, but it’s also $ 15,000 in which you won’t have a chance to earn interest.

Keep your eyes on the prize

Long-term investors should focus on just that: the long term. If your portfolio is getting hit by a stock market correction, change your mindset and consider it an opportunity instead of something to scare. Warren Buffett put it all in perspective when he said, “You’re scared when others are greedy and greedy when others are scared.” Your long-term goals should not change due to short-term market trends. Follow the course and keep your eyes on the prize.

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