ASX shares can be a great wealth-building tool for the long term if we let those returns compound.
If I had $10,000 to invest today, I believe it would be much better to invest in a longer-term timeframe, such as 2030, rather than a short-term period, such as 2025.
Many investors can get caught up in how a stock could perform in the next 12 months or how it has done in the last 12 months. Of course, those time periods are important, but I think we can achieve the best results if we think about longer timeframes due to two key factors.
Compounding of earnings
One of the best things about owning ASX shares is that they're capable of growing profit. Virtually every business wants to grow its profit, and management is focused on efforts for that goal.
Somewhat frustratingly, in the short term, the market seems to be focused on how businesses perform compared to profit expectations. The share price can go down even if profit rose strongly because the market expects even more. That makes it much harder to know what share prices are going to do over the short term. It's difficult to know whether a business is going to underperform or outperform in the next result.
Of course, it can be an investing opportunity if the market is underestimating how much profit that ASX share could make in the next result.
However, in the long term, I think the growth of the business' earnings will play the biggest role. There's a big and clear reason why companies that generate the most earnings growth are able to deliver market-beating returns over multi-year time periods.
Think of it this way: Would we buy a property with the thought it had to perform well in just one year and we're planning to sell it after 12 months if it hadn't generated gains yet?
When business earnings compound, they can quickly become a much larger profit figure after two years, three years, five years, or even longer. Investing in ASX shares with 2030 in mind can allow us to focus on how much profit growth the company could generate over seven years rather than just one. It gives more time for a compelling investment case to play out successfully.
Albert Einstein reportedly loved the power of compound interest and once said:
Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn't, pays it.
Capital gains tax
Selling successful investments too early can also be a mistake because it triggers a capital gains tax event. If a sale is made, it needs to be reported to the ATO in the next tax return, which may result in some of the gain being taxed.
Losing some of the gains that I've made to tax is not an ideal outcome if there is still plenty of capital growth potential left for that ASX share. Transacting that sale means I need to find an investment that can provide stronger returns than the successful investment I already own, and it'd need to make up for the taxes lost too. It may be a tall order to find an investment that's that compelling.
I often like to say that winners tend to keep winning, so it'd probably be best to let a good ASX share investment keep going – it can often positively surprise you by how long it can keep growing earnings.
