What are Long-Term Investments: All You Need to Know

The stock market is one of the best places for everyone’s investment needs. The stock market offers great flexibility to all investors in the form of expansive investment avenues. An investor’s goals and risk appetite usually changes with time. The stock market has enough options to satisfy any investor’s ever evolving needs. All investors have their specific needs and financial goals. Your investment options should be chosen based on those needs and goals, and not randomly. Your financial plan should consist of clear cut goals and a time horizon within which those have to be achieved. In case you want to plan for retirement or buy a house, you will generally have to invest for a longer duration. For short term goals such as buying a car or a new electronic appliance, you will need to invest in assets which have good liquidity and the money is locked in for a small amount of time. With varying goals, the type of investment assets also start varying. You should differentiate between your financial goals on the basis of time horizon and then invest accordingly in short term investment tools and long term investment tools. In case it’s a little overwhelming for you to do it by yourself, you can also enlist the help of some financial planners to help you out with it. In this post, we will discuss long-term investments in detail and also discuss the difference between short term investments and long term investment briefly. Let’s get started.

Long-term Investments: All You Need to Know

What’s the difference between long-term and short term investment?

Here are some popular types of short term investments:

Treasury Bills:

These short term investment tools mature in less than 91 days. These are perfect for investors who want high levels of liquidity.

Gilt Funds:

These funds don’t have any credit risk and exclusively invest in government securities.

Ultra short term Debt Funds:

These usually have a maturity period ranging between 3-6 months and offer better returns compared to other high liquidity funds.

Large Cap Mutual Funds:

As the name suggests, a large chunk of your money gets invested in companies with large market-capitalization. These funds can generate good returns in a short period of just 1-3 years. Large cap mutual funds offer stable returns and come with very little risk as your money is invested in companies that are well established.

Here are some popular types of long term investments:

Stocks:

Investing in stocks is one of the best ways to generate a good amount of returns. There are numerous stories of investors who bought stocks at very low prices over a few decades ago and have become millionaires as a result of the growth in price. However, you must do your research and properly understand the growth prospects and future potential before putting your hard earned money in the company for a long term. As the stock prices tend to move up and down, a careful approach and guidance is needed when it comes to the topic of holding, buying or selling stocks. The best decisions in the stock market are always the most well researched and well thought out ones.

Equity Mutual Funds:

Investors with high risk appetites can choose to invest in equity mutual funds especially in mid cap and small cap funds since they can generate higher levels of returns.

Where should you put your long-term investments?

Long-term investments are generally held in retirement accounts such as Roth and traditional IRAs, Roth and traditional 401(k)s, and 403(b)s. An IRA can be opened by anyone, while a 401(k) or 403(b) has to be provided by your employer.

In case you are saving for a child or grandchild’s college education, you are better off with a 529 account. This kind of account is a special savings account that will also provide tax benefits when you use its funds for specified education expenses like tuition, books, and college housing.

Another option for long-term investing is a brokerage account. However, these accounts are situation specific and don’t work for everyone. One advantage of brokerage accounts is that they have fewer rules than retirement accounts, but they also don’t have any tax incentives.

If you’re saving for a vacation home to buy in 20 years, a brokerage account may be better than an IRA or 401(k) because you won’t be penalized for withdrawing funds before the age of 65. Unless you’ve maxed out your IRA or 401(k), opening a brokerage account isn’t recommended for you.

Health Savings Accounts (HSA) are another popular vehicle for long-term investments. As the name says, HSAs help investors save money for health related expenses. All contributions made to the HSA are tax-deductible, and funds can be withdrawn tax-free.

After your HSA levels reach a certain level, usually between $1,000 and $2,000, you have an option to invest that money in mutual funds and ETFs.

HSAs are great for long-term investing as the earnings are tax-free and you can withdraw money for medical expenses as and when you need it. Once you turn 65 years old, you can choose to withdraw it for any reason. However, you will have to pay a standard income tax on it.

What are some of the best long term investment options for 2020

If you’re ready to start investing for the long-term, here are some great options for you:

1. S&P 500 index fund

The S&P 500 has been the standard against which other stocks and funds are measured for many decades now. It’s one of the biggest reasons why investing experts sing praised for S&P 500 index funds.

“You can do very well if you just buy and hold a low-cost S&P 500 index fund,” said Ryan Sterling, founder of Future You Wealth.

This index fund follows the S&P 500 index. This index includes over 500 largest publicly-traded companies in the U.S. Ever since it was launched in 1957, the S&P 500 has given an average annual return of 8% annually.

Most S&P 500 index funds usually come with low fees. This is a critical advantage in long term investing. According to financial planner and President of Sabela Capital Markets, high fees are lethal to portfolios. He says: “It’s important to remember that costs do not correlate with returns. In fact, the lower your costs, usually the higher will be your expected returns.”

2. Bond funds

If your primary investment goal is saving for retirement, you must have bond funds in your portfolio, regardless of your age. A bond fund comes with a wide variety of bonds from both corporate and government sources. The government bonds in a bond fund generally include local and federal government bonds.

Bond funds do a great job of balancing a portfolio. When stock funds do well, bonds usually don’t. But when stock funds tumble, bonds pick up the slack. In general, bonds are stable and almost never experience large swings in value. Because of that, they are a great security blanket for your portfolio and will ensure that you won’t lose all your money even if the market is extremely volatile.

Investors decades away from retirement should construct their portfolio in such a way that between 10 to 20% of their portfolio is invested in a bond fund, while those only five or 10 years out may have the majority in bonds.

An easy way to decide how much to invest in a bond fund is by using your age. At 30 years old, bond funds should make up 30% of your portfolio. This should increase with age and by the time you turn 45 years old, 45% of your portfolio should be made up of bond funds.

Most reputable bond funds also have low fees, so you won’t pay extra for the security bonds provide. Look for bond funds with an expense ratio of .5% or less.

3. Total stock market fund

A total stock market fund quite similar to the S&P 500 index fund. However, there are some key differences. While both of these funds have large-cap companies, total stock funds consist of some small and mid-cap companies.

The smaller companies are very important for this fund’s success. Since small and mid-cap companies are typically younger, they tend to have more growth potential than large-cap companies.  Investing in a total stock market fund exposes you to a wide variety of companies.

Like S&P 500 index funds, total stock market funds also tend to have low fees. Their returns are quite comparable to the returns coming from the S&P 500 index.

4. Target-date fund

A lot of investors like being very actively involved with their investments and getting their hands dirty, checking on stocks daily and tracking the progress of their portfolio from every angle. However, a lot of investors also prefer a more laid-back approach.

Investors who prefer a more laid-back approach and prefer to be more hands-off, should try out target-date funds. Target date funds are designed in the ”set it and forget it” manner. All you need to do is put money in a target-date fund, let it sit and grow for 30 years and only withdraw once you’re ready. A lot of investors use target-date funds for their retirement accounts.

Target-date funds have a mix of stock and bond funds. If you pick a target-date fund as a twentysomething, the fund will be mostly made up of stock funds. As you get older, the fund will start to replace some of those stock funds with more bond funds.

Target-date funds are generally great for removing the guessing aspect from investing. Investors never have to rebalance their portfolio according to market movements, as the target-date fund does it by itself.

Target-date funds usually come in five-year increments. The fund is named based on the year you intend to withdraw it. For example, if you want to retire in 2058, you’d pick a 2060 target-date fund.

However, you must remember that target-date funds aren’t really cheap. They tend to have higher fees than a lot of index funds. The average fee hovers around .51%. By way of comparison, the S&P 500 index fund might have less than a 0.1% fee structure. Target-date fund fees are still quite low, especially when compared to numerous actively managed funds. If the ability to sit back and let your fund grow without worrying about it is important to you, you shouldn’t hesitate to pay the premium for target-date funds.

Some brokerage firms can also have low fees on target-date funds, something closer to what you’d pay with an S&P 500 index fund. Always compare offerings from different brokerage funds before investing in a target-date fund.

Why is it dangerous to invest in individual stocks for long-term investing?

Individual stocks generally have a massive growth potential. For a lot of investors, investing in stocks seems to be the only long-term investment option. However, investment in stocks is inherently risky. Whenever you invest your hard earned money in a firm, your money’s growth is directly linked with the firm’s growth over the years.

However, if you invest your money in an index fund, a particular firm’s success or failure won’t have a massive impact on your overall returns. If a firm suffers a 40% drop in a day, it would just appear as a small blip in an index fund spread out between hundreds of companies.

When it comes to long-term investing, a lot of investment experts tend to view individual stocks unfavourably. According to Mark Setee, CFP and Portfolio Manager at Wealthsimple, no one should have more than 5% of their total portfolio in stocks.

“This way, if the stock goes up, great,” he said. “If not, the stock isn’t going to sink your ship financially.”

In case you choose to invest in individual stocks, you will be required to actively manage your portfolio by yourself. The biggest reason behind that is the massive impact that the ups and downs of a single stock can have in your portfolio. A lot of people don’t want to do that and a lot of people might lack the expertise and knowledge required to do so. According to Dora Waters, Registered Investment Advisor and President of DP Waters Wealth Management LLC: “If you invest in an individual stock, you have to pay more attention to this company’s financial reports, management changes, product changes, etc. as well as the industry background and the relevant laws and regulations.”  This is one of the big reasons why you should try index funds for long term investment.