Long-Term Investment: A Beginner’s Guide
PUBLISHED: Nov 30, 2021
Whether you’re saving for retirement or other long-term financial goals, owning long-term investments is a smart idea. They could help you minimize your tax liability and build wealth. But if you’re new to investing, you may be unsure about where to begin and what investment options are available.
Here’s a guide that covers how long-term investments work, different types and the pros and cons of using a long-term investment strategy.
What Is A Long-Term Investment?
A long-term investment is an asset such as real estate or stocks within an investment account a company or person plans to hold for more than a year. Long-term investments can generate additional income if they appreciate in value and are later sold for a profit.
How Do Long-Term Investments Work?
The long-term investment process starts when you purchase an asset. For example, say you open an online brokerage account and purchase $10,000 worth of a company’s stock. Holding the stock for longer than a year would make it a long-term investment.
If the stock pays a dividend and you reinvest the earnings, you could earn more money. And the longer you choose to hold the stock, the greater the chances of your investment compounding.
Types Of Long-Term Investments
There are several types of investments that long-term investors hold in their investment portfolios for diversification purposes, including:
- Stocks: Buying shares of a company’s stock or a basket of stocks is one of the most popular ways to build long-term wealth. When you own a stock, it makes you part owner of a company. Holding this asset long-term means you’re likely to experience short-term dips, also known as volatility. But if the price of a stock (or basket of stocks) increases over time as is typically expected, you’ll grow wealthier.
- Bonds: Bonds are offered by corporations and governments. When you purchase a bond, the issuer agrees to pay you back in a certain time period, or term. Since you typically must hold bonds for at least 12 months before cashing in, you can include them in your long-term investment strategy.
- Mutual funds: A mutual fund is a type of investment that allows you to pool your money with other investors to purchase a mix of securities, including bonds and stocks. One benefit of choosing this type of investment is that it provides a simple way to diversify your portfolio.
- Exchange traded funds (ETFs): An ETF is a basket of similar securities. There are several types of ETFs, including bond and stock market ETFs. Some ETFs track a certain market index, like the S&P 500. Similar to a mutual fund, it provides an easy route to diversification and can help you build long-term wealth.
- Certificate of deposits (CD): A certificate of deposit it a type of savings account you open with a bank. Unlike a traditional savings account, you are giving the bank money for a set period of time. Agreeing to a longer term can result in receiving a higher fixed interest rate. In general, you can choose a payment term of up to 10 years. The only downside is that you may have to pay a penalty if you withdraw your money before the term expires.
- Gold: Investing in gold as a part of a diversified portfolio can be a smart decision. It is sometimes touted as a hedge against inflation, but some experts disagree.
What Are The Best Long-Term Investments?
When building your portfolio, it’s a good idea to have a mixture of different asset classes. Why? It diversifies your portfolio and it could minimize risk.
Growth Stocks
Growth stocks are shares in a company that is expected to have above-average earnings, compared with other companies in its industry. As a result, the stock price of these companies tends to experience tremendous growth over time. Adding growth stocks to your long-term portfolio could provide you with higher returns.
However, keep in mind that growth stocks come with more risk and tend to be more volatile.
Dividend Stocks
When you purchase a dividend stock, a company regularly sends you a percentage of its profits in the form of a dividend. You can choose to cash out the dividend or reinvest it to purchase additional shares (or fractional shares). If you choose the latter option, it could boost your long-term returns.
Stock Funds
A stock fund – a fund that consist of different company stocks – can also be a good long-term investment. The quality of the fund, however, will depend on what type of stocks a portfolio manager includes. While some stock funds track a certain market index, others track a certain sector (like technology stocks).
Bond Funds
Similar to stock funds, investing in bond funds means you’re investing in an already diversified portfolio of bonds for a relatively low entry cost. It’s important to research more about bond funds before investing as long-term bond funds can have a larger inherent risk due to volatility than shorter-term bond funds.
Real Estate
Real estate investing is a great way to bolster your long-term investment portfolio. You could hold an investment property and collect passive rental income, or simply hold property to benefit from property value appreciation. Note that investing in real estate is far less liquid than other investment types and may require significant capital up front.
How To Invest Long-Term: The Buy And Hold Investment Strategy
One strategy you can use to invest long-term is the buy and hold investment strategy. The way this works is that you purchase an investment and you choose to hold it for more than a year. Whether this strategy is right for you depends on your risk tolerance and age.
The younger you are, the more time you have to take risks. But as you grow older, experts usually recommend that you have a more conservative portfolio. And your investment time frame often becomes shorter.
Long-Term Investment Vs. Short-Term Investment
A short-term investment is an asset a person or company holds for less than a year. When you purchase a short-term investment, your goal is to buy an investment and sell it for a quick profit.
One major difference between a short-term investment and a long-term investment is how they are taxed. For instance, when you sell a stock that you’ve held for less than a year, you’ll pay short-term capital gains taxes. This means you’ll pay taxes at your ordinary income tax rate.
However, if you sell a stock after holding it for longer than a year, you’ll pay a long-term capital gains tax. It’s a more favorable tax that ranges from 0% – 20%.
An investor may choose a short-term strategy over a long-term strategy when they need to achieve a financial goal in a short time period. For example, if a person wants to buy a house soon, they may choose to put their down payment in a short-term CD or high-interest savings account to earn some interest.
It’s important to note that you don’t have to choose one strategy over the other – you can choose both.
Pros and Cons Of Long-Term Investing
Although long-term investing can help you save money on taxes, it does come with some drawbacks. Let’s go over some pros and cons.
Pros
- Compounding: Holding your investments for a longer time allows your returns to compound, which gives you a better chance of growing your money.
- Tax advantages on capital gains: When you hold your stock investments for longer than a year, you’ll be taxed at the more favorable long-term capital gains tax rate, which ranges from 0% – 20% for the 2021 tax season. Your individual rate will depend on your taxable income and filing status.
Cons
- Fees: The longer you invest, the greater the impact fees, such as expense ratios and financial advisor fees, can have on your portfolio. These fees can decrease the value of your portfolio over time.
- Volatility: When you have a long-term investment horizon, you’ll be exposed to a lot of volatility. If the market crashes, you may be tempted to sell your investments instead of staying the course.
Long-Term Investment FAQs
Here’s a list of common long-term investment questions.
Why and when should I begin long-term investing?
You should begin investing your money as soon as possible. The earlier you start, the longer your money has a chance to compound.
How much should I be saving for long-term investing?
Fidelity – a large investment management firm – recommends that you save at least 15% of your pretax income for retirement. However, the amount you should save depends on your age, income, how much you’ve already saved and desired retirement lifestyle.
In addition to retirement funds, you may want to fund other long-term financial goals, such as contributing to a child’s college fund or saving for a dream vacation.
If you need help estimating how much you need to save long-term, consider contacting a financial advisor.
Is it better to invest a lump sum or make recurring long-term investments?
While some studies have shown that one strategy can be better than the other in certain scenarios, the answer depends on your risk tolerance and the type of investments you own. Before you choose lump sum or dollar-cost averaging, weigh the pros and cons.
If you decide to do lump-sum investing, the main advantage is that you put your money to work in the market immediately. As a result, you won’t miss out on any potential growth. However, a potential disadvantage is that you might be tempted to sell if the price of stock drops. And if you sell, you’ll lock in a permanent loss.
On the other hand, dollar-cost averaging, in which you invest a set amount spaced over regular intervals, allows you to spread out your risk over a certain time period. If the price of the stock drops, you’ll buy more shares. And as it rises, you’ll purchase less shares. A potential benefit of this is that you might pay a lower average price per share.
However, a downside of this strategy is that you might miss out on potential gains if the stock price rises sharply.
When should I sell a stock for my long-term investment?
Deciding when to sell a stock is a personal decision. That said, here are some reasons you might choose to sell:
- You may choose to sell for retirement income
- You want to rebalance your portfolio
- You want to use the funds for some other purpose
In addition, you may also sell some shares to trigger capital losses – a process known as tax-loss harvesting. Before you sell any investment, however, make sure you’re aware of any potential tax consequence and consider contacting a financial professional.
How will taxes factor into my long-term investment strategy?
How taxes will affect your long-term investment strategy varies based on the type of investment accounts you choose. For instance, If you contribute to a pretax retirement account, such as a traditional IRA or 401(k), you may qualify for a tax break when you file your tax returns.
However, if you put some of your retirement funds into a Roth IRA, you won’t get a tax deduction since your contributions are made with after-tax dollars.
When you decide to withdraw funds from your pretax retirement accounts, you’ll be responsible for paying income taxes. The amount you must pay will depend on your income tax bracket at the time and your age.
Bottom Line
Long-term investing has several benefits, like lower taxes and a better chance of growing your money. However, it also comes with the risk of losing money. To increase your chances of long-term success, it’s important to be patient and understand your risk tolerance.
If you need help creating a personalized long-term investment plan, consider contacting a financial advisor.
If you’re ready to apply what you’ve learned, read our article on how to invest in stocks to get started.
Jerry Brown
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