Many people think of investing as a way to get rich quickly. After all, when the news is filled with stories about people becoming wealthy from day trading and cryptocurrency, it’s hard not to think it’s a short-term game. But the truth is the most effective investment strategy is a long-term one. It may not be as flashy or exciting as some of the investment strategies you’ve seen in the news or on social media, but it’s a proven method.
If you’re ready to build your long-term investment portfolio, we’re here to help. Keep reading to learn more about how long-term investments work, the best long-term investments for your portfolio, and whether a long-term investing strategy is worth it.
What are Long-Term Investments?
Long-term investments are those designed to help you make money over a long period of time. A long-term investment is designed for a long time horizon, meaning you won’t need the money for many years. In general, a long-term investment strategy means putting your money into an investment — or a handful of investments — and allowing it to sit for many years.
Long-term investing is what most people do when they’re saving for retirement. As you contribute money to your 401(k) plan or individual retirement account (IRA), you aren’t planning to withdraw it any time soon. You won’t need that money anytime soon, and you know you can withstand the ups and downs of the market because your portfolio has a long time to recover.
Long-term investments differ from short-term investments in several ways. First, when people invest for the short term, they often turn to lower-risk investments because they don’t have time to wait for the market to bounce back. On the other hand, long-term investments tend to be those with a bit more volatility.
Another difference is their time horizon. Short-term investments have flexible withdrawal options and high liquidity. You can easily withdraw your money at any time. While many long-term investments still make it easy to withdraw your money, that’s not always the case. Some long-term investments, including real estate, have low liquidity, meaning it’s hard to get your money back. And many long-term investments live in tax-advantaged retirement accounts that penalize you when you withdraw your money early.
Types of Long-Term Investments
Are you looking for long-term investments for your portfolio? In this section, we’ll talk about some of the most popular types of long-term investments, why they’re popular, and how you can use them to grow wealth.
When you buy stock, you’re essentially buying a share of ownership in a publicly-traded company. And among the benefits of owning stock is the chance for capital appreciation, dividend payments, and a vote in shareholder elections.
There are two different ways you can financially benefit from stocks. First, you can see your position grow when the shares you own rise in value. For example, if you own a particular stock for years or decades, and the value continues to appreciate, you can sell the stock during retirement for far more than you bought it.
The other way you can make money from stocks is through dividends. A dividend is when a company passes a portion of its profits along to its shareholders. Not all stocks pay dividends, but many dividend stocks can provide a regular source of income for a shareholder.
Even within the category of stocks, there are many options to choose from. For example, you can choose between growth versus value stocks. Growth stocks are those that are expected to experience major growth. This is often the case with newer companies and those in innovative industries like technology. Value stocks, on the other hand, are often more established companies that are underpriced currently but can provide solid long-term growth.
Investors can also choose stocks from a variety of different company sizes.
- Large-cap stocks have a market capitalization of more than $10 billion. These companies are some of the largest in the stock market and are the most reliable.
- Mid-cap stocks have a market capitalization between $2 billion and $10 billion. They offer more stability than small-cap stocks, but more growth than large-cap stocks.
- Small-cap stocks have a market capitalization of less than $2 billion. While they are riskier than larger companies, they also have an opportunity for significant growth.
A bond is a type of debt security, meaning the investor is lending the bond issuer money. The bond issuer makes regular interest payments to its lenders. The investors can make money from the interest paid by the bond issuer, as well as from capital gains if they’re able to sell the bond for more than they bought it.
Bonds can be issued by many different entities, including governments and public companies. Bonds issued by the federal government are for the most part, considered risk-free, while corporate bonds have a somewhat higher risk. However, bonds overall are considered a lower-risk investment strategy than stocks, especially if they come from a government entity or a creditworthy corporation.
Bonds are an important part of a long-term investment strategy because they can provide risk management. They typically aren’t as volatile as stocks and can provide some portfolio returns during a time when the stock market is down.
3. Mutual Funds
A mutual fund is a type of investment vehicle that pools money from many investors and buys a selection of underlying assets. Mutual funds invest in hundreds — or even thousands — of assets, including stocks and bonds.
Mutual funds generally come in two forms: active and passive. An active mutual fund has a fund manager that actively buys and sells stocks to try to beat the market. A passive fund, on the other hand, tracks the performance of an underlying index or portion of the market, such as the S&P 500 or the technology sector.
The benefit of a mutual fund is they allow for portfolio diversification. Rather than an investor having to buy hundreds of assets themselves, they can simply invest in mutual funds to create a more diversified portfolio with as little as a few investments.
Mutual funds also have some downsides. All mutual funds require some fees, but actively-managed funds are notorious for their high management fees. They may also result in some unexpected tax consequences. As a fund manager buys and sells assets, gains are passed along to investors, who may be on the hook for capital gains taxes.
4. Exchange-Traded Funds
An exchange-traded fund (ETF) is quite similar to a mutual fund in that it’s a single investment vehicle with many underlying assets. Investors can diversify their portfolios and gain exposure to many assets with a single investment.
ETFs have a few differences from mutual funds. First, unlike mutual funds, which trade at the close of the trading day, ETFs trade throughout the day on exchanges like stocks. ETFs are also more likely to be passive funds, meaning their objective is to match the stock market rather than beat it. As a result, investors may face less risk and fewer tax consequences.
5. Target-Date Funds
A target-date fund is actually a type of mutual fund, but it’s worth discussing on its own because of its popularity as a long-term investment. Each target-date fund corresponds to a particular retirement year, and all investors who buy into the fund have a similar time horizon.
Each target-date fund has a selection of underlying assets, but it also has a fund manager that adjusts the fund’s holding as the retirement year nears. The closer you get to the retirement year, the less risk the fund has.
A target-date fund is meant to be an all-in-one investment. It includes a selection of stocks and bonds that allows investors to hold just one asset in their portfolio. These funds are especially popular in 401(k) plans.
Of course, there are also downsides to target-date funds. They are designed to accommodate all investors who plan to retire in a single year. As a result, the risk tolerance of the fund for your retirement year may not line up exactly with your actual risk tolerance. If you’re more or less comfortable with risk, then you may find the fund doesn’t work for you.
6. Real Estate
Real estate remains one of the most popular long-term investments. Like stocks, real estate can be profitable in several ways. First, you can make money when the property you own appreciates over time, as real estate has done historically. You can also earn a recurring source of income from the rent your investment property brings in.
One of the most attractive perks of real estate is that you can make this investment with the bank’s money at a low interest rate. Rather than buying an investment property in cash, many people use bank loans, which can often be taken out at low interest rates.
Of course, there are downsides to real estate. First, as we saw in the real estate crash in 2007-2009, the value of real estate doesn’t always go up. And anyone who tried to sell a property during that time likely lost money. And unfortunately, it’s a highly illiquid investment, since your money is tied up in the property and you can’t access it unless you sell or borrow against your equity.
Another downside of real estate is the amount of work required. The property owner is on the hook for all maintenance and repairs, which can result in high costs and a lot of manual labor.
A real estate investment trust (REIT) is a way for investors to add real estate to their portfolios without actually owning real estate. An REIT is actually a stock in a public real estate company. Each investor in the REIT is essentially a partial owner of the properties the REIT owns. And all owners get a share of the rental income and the profits.
When you invest in an REIT, you get many of the benefits of owning real estate with less risk and less hard work. Someone else manages the properties so you don’t have to. And unlike physical property, you can sell your REITs at any time to create liquidity when you need it.
8. Alternative Investments
Adding alternative investments to your portfolio can be an effective way of creating more diversification in your portfolio, along with the potential for growth. An alternative investment is generally anything outside of the traditional asset classes of stocks and bonds.
There are many types of alternative assets, including commodities, gold, and private equity. Alternative investments can also include assets like art or collectibles. Finally, cryptocurrency is considered an alternative asset and has become increasingly popular in recent years.
Long Term Investing Tips
Are you interested in building a long-term investment strategy? Here are a few tips that can help:
1. Know Your Time Horizon
The most important first step to creating your long-term investment strategy is identifying your time horizon. After all, you’ll need a very different strategy if you’re investing for retirement versus investing for a goal that’s only five years away.
Knowing your time horizon can help you properly diversify your portfolio, choose the right amount of risk, and know when to adjust your portfolio.
2. Be Intentional with Investment Risk
Risk is one of the most important factors to consider when creating your long-term investment portfolio. First, there’s a direct relationship between time horizon and risk. In general, you can afford to take on more risk with a longer time horizon. But as your time horizon shrinks and you get closer to your financial goal, you may want to reduce the risk in your portfolio.
Your investment risk also depends on your risk capacity. Someone with a high income and a lot of money in savings and investment has the capacity to take on more risk than someone who will absolutely need the money they’re investing someday.
Finally, you must consider your risk tolerance. While your risk capacity is the amount of risk you can afford to take, your risk tolerance is the amount of risk you’re comfortable with.
Those with a high risk tolerance may feel comfortable adding alternative assets like cryptocurrency or venture capital to their portfolios while ignoring lower-risk assets like bonds. On the other hand, someone with a low risk tolerance might opt for only stocks and bonds, with bonds making up the largest portfolio of their portfolio.
3. Focus on Diversification
Diversification is one of the most important principles of investing. A well-diversified portfolio can help to reduce your investment risk. First, by having many assets in your portfolio, your financial success isn’t dependent on the performance of a single company or a few companies.
Diversification can also reduce your investment risk by pairing low-risk investments with more volatile ones. For example, a well-diversified portfolio is likely to have both stocks and bonds rather than just one or the other.
When you’re deciding how to diversify your portfolio, remember you’ll want to diversify in two key ways: within asset classes and across asset classes. Diversifying within an asset class means buying many different assets within that class, such as stocks from many different companies instead of one. And diversifying across asset classes means adding a variety of asset classes to your portfolio.
4. Get Comfortable with Buy and Hold
It can be tempting to watch your investment portfolio like a hawk and adjust it as things change in the market. You may be tempted to buy and sell new assets as they become popular, or sell off investments as they lose value.
But to really achieve long-term investment success, you have to get comfortable with a buy-and-hold strategy. The fact is the market will go through ups and downs. And it’s only those investors who hold their assets when the market is down who will likely have the most success.
Not only can a buy-and-hold strategy increase your investment success, but it also reduces your tax burden. Actively buying and selling assets throughout the year can put you on the hook for higher capital gains taxes, which will eat into your investment returns.
5. Pay Attention to Fees
It’s important to pay attention to the fees for any asset you add to your portfolio. For individual assets like stocks and bonds, you may have trading fees and commissions. And for mutual funds and ETFs, you’re likely to pay an expense ratio, which is an annual fee that helps to cover the management costs of the fund.
You would be surprised just how much fees can eat into your investment returns, especially on funds you’re holding for a long period. The good news is there are plenty of low-fee funds — and even funds without fees — that can help you to keep more of your investment returns.
6. Rebalance and Adjust As Needed
We’ve talked about how a buy-and-hold strategy is best for long-term investing. At the same time, simply building your portfolio and letting it sit until retirement may not be ideal. Over time, you’ll want to rebalance and adjust as needed.
First, you’ll find that some of your assets will grow more quickly than others. For example, your stock investments are likely to grow more quickly than your bond investments. As a result, you may eventually need to rebalance to get back to your desired asset allocation.
You’ll also want to adjust your investment portfolio as time passes to match your time horizon. The closer you get to your financial goal, the less risk you’ll want in your portfolio.
Are Long-Term Investments Worth It?
It’s easy to second-guess whether a long-term investment strategy is really worth it. After all, aren’t people getting rich all the time by day trading and other short-term investments?
While it’s true that you can make money from short-term volatile investments, it may not be the best route for most people. First, you might be surprised to learn that most people who employ that investment strategy ultimately lose money.
A long-term investment strategy, despite often including volatile investments, actually reduces your risk. The reason is that you have more time to bounce back from any market downturns. If you’re in your 30s and you lose half of your investment portfolio in a stock market crash, you have another 30 years to rebuild.
Finally, a long-term investment strategy may be the most appropriate for the investment goals that most people are working toward. For most people, retirement is their primary investment objective. And for that purpose, a long-term investment strategy can be the most effective.
The Bottom Line
Preparing for retirement is part of your overall financial plan. You can take a few actions now to get yourself on the right track.
- Download 65 Ways to Retire Smart, an actionable guide with insights from fiduciary financial advisors. The guide is free.
- Sign up for the Personal Capital Dashboard. Millions of people use these free and secure professional-grade online financial tools. You can use them to see all of your accounts in one place, analyze your spending, and plan for long-term financial goals.
- Consider talking to a fiduciary financial advisor for more detailed guidance on your retirement saving strategies.