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Long-term investing has different meaning in different contexts. In accounting, a long term investment is an item in the balance sheet listed under the asset column, which a company holds for more than a year from the balance sheet date.
Meanwhile, for investors, long-term investing is buying and holding a security for a longer term, usually for over a year. The length of the investment horizon for a longer-term investment varies. For stocks, it could be any time over a year, while for long-term bonds held till maturity, it could be ten years or possibly more.
Alternatively, short term investing involves a time period of less than three years, and the asset classes generally categorized as short term investments are bonds or bond funds, with duration of one to three years, money-market funds, certificate of deposits, stocks, etc.
Unlike short term trading, long-term investing is built on the foundation of fundamentals and macroeconomic conditions.
For information about short term investing, don't miss Benzinga's Best Short Term Investments.
Merits of long-term investing
A long term investment helps reduce transaction costs. Additionally, investing in taxable assets provides you with incremental wealth, which is compounded over time.
What's more, you also save time because you only work on finding a quality investment. Later on, you'll likely only have to check your accounts occasionally.
Strategies for long-term investing
- As with any investment, starting early is a must. Returns on an investments made during your early years will compound, earning you more money over time.
- Even if the value of your holding drops, it's better to stick with it, rather than liquidate it. This is especially true when the asset price drops. The very premise behind long-term investing is that losses will even out over time.
- It's important to identify poor performers early on. High-quality assets should be held even amid losses, as they wield potential to make a strong comeback.
- Learn the importance of rebalancing. As you age, the proportion of safer securities such as bonds could be increased at the expense of risky assets.
Best long-term investments
- Stocks, including index funds, mutual funds, ETFs, DRIPs, etc.
- Real estate
- Savings accounts/CDs
- Collectibles such as art, restored antique cars, etc.
A Statista analysis showed that in 2016, 35 percent considered real estate as the best long-term investment option. This was followed by stocks/mutual funds at 22 percent. About 17 percent considered gold as the best investment option compared to 15 percent for savings account/CDs and 7 percent for bonds.
Stocks are highly volatile, and investing short term in this asset class could be ultra-rewarding at times. However, you'll have an equal chance of losing money as you do earning it.
The best way to take risk out of the equation is to identify some quality stocks and stay invested in them for the long term.
Average annualized stock market return, taking the performance of the S&P 500 Index as a proxy, has been 15.5 percent over the past five years and a more modest 8.8 percent over the past ten years.
An analysis of long term investment returns over an 84-year period, from 1926 to 2010, which included three market crashes, showed that adopting a buy-and-hold strategy would have netted a return of 12.1 percent with small stocks and 9.9 percent with large stocks, which are excellent returns overall.
Check out How to Invest in Stocks for a quick tutorial.
Choosing long-term stocks
In order to pick individual stocks to hold long term, you'll have to consider several factors, including:
- Price-earnings ratio or P/E ratio, which helps to determine if a stock is overvalued or undervalued. It is calculated by dividing the market price by the earnings per share. In order to determine whether a stock is a value buy, its P/E is compared to the P/E of the overall industry. A stock is attractive if its P/E is at a discount to the overall industry P/E.
- Consistent earnings and revenue growth.
- Consistency in paying out dividends.
- Macroeconomic conditions
Billionaire investor Warren Buffet recommends investing in some index funds. A S&P index fund consists of all stocks that are part of the index.
The turnover rate, which is the percentage of a fund’s holding that change every year, is low, so the associated fees and taxes are also low.
Especially for retirement savings, Buffet recommends consistently buying an S&P 500 low-cost index fund.
Exchange Traded Funds, or ETFs, are marketable securities that track indexes, commodities, bonds or an index funds. These are traded like shares on a stock exchange, and due to the higher liquidity and lower cost compared to mutual funds, ETFs have gained in popularity in recent years.
Even among ETFs, index-based ETFs are a better bet for long-term investing. Some index-based ETFs include:
- SPDR S&P 500 ETF Trust (NYSEARCA:SPY)
- SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA)
- PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ)
- iShares Russell 2000 Index (ETF) (NYSEARCA:IWM)
- Vanguard Total Stock Market ET (NYSEARCA:VTI)
A dividend reinvestment plan, or DRIP, is a plan which allows investors buy shares of companies instead of the cash dividend due to them.
Long-term investors who shortlist a few good businesses with an intention of buying and holding can use this option to increase their ownership in these companies at a very low cost.
A bond is a debt instrument issued with the purpose of raising capital. A bond investor lends funds to the issuer for a fixed period in return for periodic interest payments and the repayment of principal. Bonds are usually issued by companies, municipalities, states, governments, etc. to finance their projects and activities.
Bond maturities can range from less than one day to over 30 years. However, longer-dated bonds are considered more risky than ones with shorter maturity periods, given the impact changing interest rates can have on bond values and returns.
For long-term investing, there are three types of bonds:
- Treasury bonds and savings bonds issued by the federal government
- Municipal bonds issued by cities, regions or states
- Corporate bonds issued by public or private companies
Treasury and savings bonds are the most secure bond options available. Municipal bonds are less risky, relative to corporate bonds, and are rated as AAA, AA, or A; AAA is the least risky and A is the riskiest.
For the ten-year period ending Sept. 30, 2014, average annual return of the Barclays Aggregate U.S. Bond Index, a proxy for the domestic bond market, was 4.62 percent compared to the 8.11 percent return for the S&P 500 Index.
The performance of bonds pale in comparison to developed-market international stocks, which returned 6.32 percent on average annually, and emerging market stocks, which fetched average annual returns of 10.68 percent.
However, the appeal associated with bonds is their safety. Also, bonds are the only avenue for diversifying your portfolio, helping to smooth out the volatility associated with stocks. There could be periods, especially during uncertain times, when bonds could outperform stocks.
A person in his or her 20s or 30s could start out with a 100 percent stock portfolio and gradually start including bonds as he or she ages.
Real estate offers an investor the dual benefit of gaining a steady income stream and benefiting from asset appreciation. From a long-term perspective, real estate investment would involve:
- Investing in basic rental property or a commercial real estate.
- A real estate investment group, a company which buys or builds apartments or condos and then allows investors to buy single or multiple units of the property. The group manages the entire property and in return, partakes in the rent due to the investors who have bought into the unit(s).
- Buying units of a good quality real estate investment trust, or REIT, which is traded on major exchanges like stocks. To acquire the status of a REIT, a company is required to pay out 90 percent of its taxable profits in the form of dividends.
Gold was once used as currency, and has since then been replaced by paper money. However, the appeal of gold as investment option has never diminished. Because of its safe haven appeal, gold is preferred by many during uncertain times.
Gold has delivered a compounded annual growth of 9.6 percent since an all-time low $250 a troy ounce in 1999. However, the commodity is still off the all-time of high of $1,895 an ounce in 2011.
There are several ways of investing in gold, such as:
- Buying physical gold.
- Investing in a gold stock such as Barrick Gold Corp (USA) (NYSE:ABX), or a gold ETF such as SPDR Gold Trust (ETF) (NYSEARCA:GLD).
- A Gold IRA.
A savings account offers flexibility in that it allows regular deposits, subject to federal ceilings.
Withdrawals are not penalized like CDs, which are meant for a fixed period. Though funds parked in a savings account earn interest, the interest rate is often lower than what is earned on a CD. The interest rate on a savings account is usually given in terms of the annual percentage yield, or APY.
APYs for a savings account in some banks are as follows:
- American Express Bank - 1.45 percent (minimum to earn APY is 0)
- Capital One360 - 1.40 percent (minimum to earn APY is $10,000)
- Goldman Sachs Bank - 1.50 percent (minimum to earn APY is $1)
- Citibank - 0.10 percent (minimum to earn APY is 0)
CDs are a preferred investment option if you're looking for a low-risk investment. A long-term CD is preferred during periods of falling interest rates, and it carries higher interest rates.
Vanguard as well as Edward Jones offer 2.85 percent on a 10-year CD. Fidelity’s 5-year CD rate is 2.65 percent.
There are several CD rates offered by different financial institutions.
Money intended for retirement savings can be parked in an Individual Retirement Account, or IRA.
For long-term planning, it's vital to identify retirement income goals. To do that, it's important to zero in on your investable surplus and then put the surplus to work through a savings program.
It's possible that the most important thing to do is analyze cash flows out of savings to determine if retirement income goals are being met.
The most widely accessible type of plan is the 401(k), which accounts for about two-thirds of total defined contribution plans.
In a 401(k), an employee can choose either to defer a percentage of income to a 401(k) account The amount saved is not taxable until it is withdrawn.
Meanwhile, in Roth 401(k), the contribution is done on an after-tax basis and therefore a subscriber to this plan need not pay tax on it when the amount is withdrawn.
Some other defined contribution plans:
- 403(b), for employees of non-profit corporations such as schools.
- 457, for employees of certain types of non-profit businesses as well as state and municipal employees.
- Thrift Savings Plan, or TSP, for federal government employees.
- Keogh retirement plan is for self-employed individuals or unincorporated businesses for retirement purposes. The Keogh plan can be structured as a defined-benefit or defined-contribution plan.
For more information, check out Benzinga's top IRA brokerages.
A collectible is any physical asset that appreciates in value over time due to its rarity and demand that people have for it.
Usually, collectibles are exchanged in antique stores, collectible retail shops, auctions, online exchanges, etc. These can be jewelry, stamps, coins, work of fine arts, etc.
For more information about brokerages for these types of long term investments, check out Benzinga's Best Online Brokerages.
Questions & Answers
It is much easier to make a lot of money long term investing than it is short term investing. This is because over time you are able to create compound interest.