A Guide To Long Term Investments
The common goal behind any form of investment is to build wealth; and the more wealth you build, the more secure you feel. Making the decision to invest money is not something you should take lightly, whether you are a business or an individual.
The key to investing is carrying out extensive research and acting on good, professional advice, because investment can be life-changing, if you get it right and if you get it wrong.
But to make a big decision about investing needs to mean that you are in it for the long haul, because long term investment is widely regarded as giving you the best opportunity to build wealth, and this article is designed to explore this area of investment and explain clearly why it is a good strategy to use.
What are long term investments?
For a business, a long term investment appears as an asset on the balance sheet, and is usually something that is intended to stay within the organisation for the long term, and certainly more than one year.
So this could be property or land, equipment or shares in another business. This means you have tied capital up in an asset for a period of time, on the understanding that you will earn money from that asset when it is realised, ie. sold.
Long term investing for individuals works much the same. You are tying money up in an investment on the basis that you don’t need access to that money for a long time.
The idea is that the investment will accumulate in value over the long term and earn money when it is eventually cashed in. A long term investment will usually be taken on in order for you to build wealth over time, to eventually cash in when you retire or at least towards the end of your working life.
If, however, you have more short term goals and need money for a more immediate project, such as a deposit for a house or to pay for a wedding etc, you may need to look at short term investments which bring rewards quicker, or at a savings strategy, which brings safer and more stable rewards, but will be less lucrative.
There are different types of long term investment and these generally differ by their level of risk. So an investment with a high level of risk will most likely bring a higher reward than an investment with a low level of risk, and you take the investment on with that knowledge and on that basis.
So there is a level of patience required in order to see the returns that you want, but that is the commitment you make. And equally, you can design an investment portfolio with a diverse mix of investments which effectively balance out.
So you can have high, medium and low risk investments, so that each is making money at different rates and the portfolio is designed so that each investment matures at the same time and you can hopefully reap the rewards.
So why should you invest long term?
Whilst there is never a guarantee that you will make money through investment, and you should always approach it with that understanding, there is statistically a better chance of making money through long term investment.
That is essentially because you are allowing time to maximise the growth potential of the asset, assuming there is some in the first place, and that is where research and professional advice comes into the equation. The attraction of long term investment is that you are keeping your money tied up in order to smooth out the inevitable peaks and troughs of the various investment markets.
There are plenty of ways to research historical data where you can spot and monitor trends in certain investment markets, and therefore calculate what amounts of money you could earn over, say, a ten year period, if the same or similar trends were to occur. Taking good advice you can therefore pick a market with the right amount of volatility to match your appetite for risk and then go for it.
It is very easy to see the value of an investment going down in the first few months and to panic and draw your money out, but this can lead to ‘actual loss’ rather than a perceived loss. By this we mean that if you take your money out when the value is down, and then it goes back up, you will lose out on that money and it can be very demoralising.
It is understandable to feel edgy about your investment in such circumstances, but this is why you need to choose a market with enough historical data to give you the confidence that the price will eventually rise again.
Long term investing is about the bigger picture
Long term investment is about holding your nerve and making a commitment, and of course you can pick a market which is more stable and has less volatility, but in this case the rewards will most likely be less.
Many people point to the Black Monday example of 1987 when trying to explain the value in long term investments. In this case the Dow Jones Industrial Average lost more than 22% of its value on October 19th 1987, one of the most dramatic drops in its history. Naturally a lot of investors sold up immediately, but those who didn’t panic and stayed committed and invested were rewarded by an equally dramatic recovery, which brought total returns of 16.6% in 1988 and 31.7% in 1989.
This is an extreme example, but it demonstrates the value of long term investment very clearly.
Another clear example of how you can benefit from long term investment is the principle of compound returns. This is perhaps best explained by imagining your investment as a snowball rolling down a hill; it gets bigger in time because with every roll it is starting with a larger surface area, and hence that larger surface area then picks up a greater amount of snow with each roll.
Similarly, if you start an investment with £1000 and earn 5% in a year, you can start the next year with an investment of £1050. Invest that £1050 and earn another 5% and you will end the year with £1102.50. And so on. If you are happy not to touch your investment and keep re-investing it for a set period, then cumulative growth in this manner can be very lucrative, in return for very little effort.
Examples of long term investments
There are many diverse and complex long term investments and it is recommended to take professional advice before entering into any investment commitment, but here we look at some of the most common forms of long term investment.
Stocks and shares
Here, you are buying a share in a business on the stock market and monitoring the value of that business either rise or fall. The idea is that you then sell the share when it has risen to an acceptable value. Shares can also drop in value, but as explained with the Black Monday example above, you need to choose a market with a good history of returns over ‘x’ number of years, or however long you are prepared to commit.
Bonds and funds
These are often known as mutual funds or exchange-traded funds (ETFs) and are numerous bonds put together to form a fund. A fund manager then invests the money for you in a wide range of assets, which could be UK shares, overseas shares or bonds, but which are tailored to match your appetite to risk and your need for reward. Your investment will be for a set period and you will receive a set amount annually in the form of a dividend. These are generally a safer and more stable form of investment and hence, the rewards are not quite as lucrative potentially as investing in stocks and shares.
Investing in property can require lots of capital, but it is a market that more people understand and find accessible. It is also relatively stable and more predictable than the stock market, for example. However, it is still possible to make bad decisions and for properties to drop in value and for your investment to go into negative equity.
To make the most money out of property you either need to sell quickly if you know the local market is improving or add value to the property and benefit from capital growth over time, usually a minimum of ten years. This long term approach does mean that your money is tied up in the property for longer, but you can release cash flow by renting the property out and earning rental income on top of hopefully the property also growing in value.
Many people like long term investment in property because it provides security, is an asset you can control in terms of adding value and you can play an active role in managing the investment. However, equally, that might be a turn-off for some investors.
The pros of long term investment
Long term investment brings more** likelihood of higher returns from investments where there is a higher level of risk**. So where an investor is happy with the level of risk involved, they are more likely to reap the rewards.
With long term investment you are riding out the natural peaks and troughs of investment markets, and by keeping your money invested you stand a better chance of maximising the growth potential of your investment, as long as you have picked the right investment in the first place.
When you leave your money invested you are saving on potential trading fees from switching investments on a whim. When you start a new investment, most are subject to associated and obligatory trading fees, so you will avoid these costs by keeping your money invested.
Long term investment is low maintenance, or at least you can design your portfolio so that you are a passive investor and can sit back and, hopefully, wait for your investment to grow. Of course you can play an active role and more closely monitor the performance of your investment, but taking good professional advice should enable you to design a portfolio that requires no monitoring, as this will most likely only cause you to worry and potentially panic.
The cons of long term investment
There is always a risk to any form of investment and there is no guarantee that a long term investment will bring financial rewards.
There is a need to be patient with a long term investment and you need to enter into this agreement on that basis. You may not see returns immediately, and even if you did, you may not be able to access that money. So patience and commitment is needed, because you are in it for the long haul.
Long term investment is not suitable if you have short term goals which need this cash injection, such as a home improvement project, a holiday or paying for your child’s wedding, for example.
Who is long term investing suitable for?
It is easy to look at the phrase ‘long term investment’ and think that it is something only suitable to a younger person. It is true that investing at a relatively early age, ie. in your twenties or thirties when you are in stable employment, for example, gives your investment plenty of time to grow, enables you to have several years of income before you need to draw on the investment and also allows you time to recover from any investment mistakes you may make.
But equally, you can make a long term investment in your mid-forties and still have 20 years until your retirement and hence, still have plenty of time for it to potentially accumulate value.
Regardless of age, the biggest characteristic in someone making a long term investment is that you need to be level-headed and able to remove emotion from the equation. This means you are able to pick a strategy and stick to it, and you don’t panic and sell-up at the merest hint of a drop in value.
Another important factor is that you can change your investment strategy as you grow older, to reflect your attitude to risk and your financial and working status. As suggested above, it may be more appropriate to take bigger risks when you are younger, because you have time in your working life to recover should it go wrong.
However, when you have maybe ten years or less to go until retirement, this may not be the most advisable strategy. So over time you could amend the diversification of your investment portfolio to reflect your age, and gradually change the emphasis to a less risky mix of investments. This should help ensure the wealth you have accumulated over the years is safeguarded and secured.
Where should I start with long term investments?
It is always advisable to start by talking to a professional for some advice. They may guide you towards certain investments, so you need to ensure you understand what you are committing to, but it is very easy to make the wrong decision because you mis-read the information, mis-timed the market or simply didn’t understand what the investment was.
There is a lot of historical data available for most investment markets, so you can understand what you are committing to, for how long, and what the expected returns are. You can match this to the amount of capital you are happy to see tied up for that period, and, let’s face it, the amount of money you are prepared to potentially lose.
You should also make sure that any long term investment matches your ambitions, so if you are saving for a student property for when your daughter goes to university, for example, will the investment mature and the funds be available in time for when you need them?
Matching your attitude to risk to the range of long term investments available is the relatively easy bit, making the commitment to think long term and leave your money alone is a bit more difficult.
However, the key to long term investment is not obsessing daily over market figures and the performance of your investment, there are plenty of short term investments available if that is what you want to do. Long term investment is about being patient, trusting historical trends and taking notice of good advice.