What is long term-investing?
When you hear the phrase long-term investing you might find yourself asking just how long does that really mean? And how long will you have to wait to start seeing the fruits of your investment labours? Well, there’s not one all-encompassing answer, as with most questions surrounding something complex like investing, but we want to offer you a little more insight into what long-term investing entails, where to invest money long-term and how the end result could make the waiting worthwhile.
How long really is long-term investing?
Generally, any asset you hold for over five years is considered a long-term investment and you usually distribute your money across a range of assets to build a diversified investment portfolio. There is usually a specific strategy in place, meaning you have an idea about what the investment funds will be used for in the future. Long-term investments are usually a game of patience because you are waiting a longer amount of time to see your rewards, and investors must be able to take on risk whilst their assets grow during their time in the market. Long-term investments show that the classic saying “time in the market beats timing the market” rings true for bringing better returns.
The importance of long-term investing
It’s important to consider the market you’re entering when selecting assets to invest in long-term, the current volatility of the market is a good example of how things can unexpectedly change and how you need to be prepared.
In the current economic climate, long-term investing may be viewed as a safer route to take for your financial future. In the past, when we have experienced a less turbulent market, it may have been more appealing to avoid long-term investments and chase short term investments which provide quick returns. But with current market volatility and high valuations, it’s worth investing your assets for the long-term. However, this can be a bit of a double-edged sword with the current volatility of the market. Whilst any short-term investments won’t boast as good as returns as they would in a stronger market, it is also nerve racking to be a long-term investor seeing the stock market suffer when you want your assets to grow. But it’s important to remember, as history shows, the markets tend to recover.
How to invest money long-term
As we mentioned above, building a diverse investment portfolio is important because it allows for balance within your investments so that you don’t have all your assets too heavily invested in one sector.
We want to help you find the best long-term investments options for your financial needs and we’ve put together some top tips for successful long-term investing:
- Know how much money you have available to invest, and how much you could potentially afford to lose without impacting on your standard of living (both current and future).
- Have a financial goal in mind – do you want the funds to be put into an account for your children? Is there a sum in mind you have for retirement?
- Select the best strategy for you and your financial wants
- Keep calm – in the face of market volatility it’s key to hold you nerve
- Understand the risks of your investments, and the risks you are prepared to take
- Start building a diversified portfolio
- Manage the costs of investing – make sure you’re aware of the costs you need to pay such as management and advisor fees
- Review your strategy regularly and seek investment where appropriate
Are shares a long-term investment?
Investing in shares is a potential way to maintain your assets ‘purchasing power’ over the long-term. In a world where inflation is rising, and the cost of living is soaring, your money’s real ability to purchase things is decreasing. Investing in the stock market may be a long-term strategy of allowing your money to grow in line with or above the rate of inflation.
So, yes, you are able to invest in shares long-term, but just like with any other long-term investment choice, we advise that investors are aware of the risks they’re taking before adding an asset to their investment portfolio. There are lots of other options to consider for long-term investments, and it’s important to remember that shares aren’t your only available route. In fact, it’s important to have multiple different assets in your portfolio to offer diversification to your investments.
Long-term investment strategies
It’s important to understand what types of investments will help you build the impressive portfolio you want. We’re going to run though some of the strategies you could consider when building your investment portfolio, but if you want to know more about the different types of investment options available to you, you can read what are the different types of investments to understand what your best options for growing your finances are.
Active vs Passive:
Firstly, there are active investment strategies, this requires a hands-on approach which is typically managed by a portfolio manager. The aim of an active manager is to beat the market returns by picking companies or sectors to invest in that they believe will do well based on market conditions and other timely factors. In other words, they use ‘active stock selection’ and often alter what they are investing in more frequently.
The aim of passive investing, on the other hand, is to track the market usually by buying index funds e.g., a FTSE 100 tracker. Passive investing typically involves less buying and selling of underlying funds and less ongoing management and in turn means the costs of investing in a passive fund is lower than their active manager counterparts. When it comes to long-term investing, both approaches may produce a capital gain, and your adviser can help assess which strategy is more suited to your objectives.
A growth stock is a type of stock in a company that is generating substantial cash flow and revenue and is therefore expected to increase their profits at a faster rate than the average company within the same industry. This strategy may sound straightforward, but there is a little more to it than just picking stocks up that are on the rise, and growth stocks tend to come with premium price tags, so you want to make sure you do your research before jumping onboard.
Stocks that exhibit the ‘growth’ characteristic derive their value from the expectation that they will grow their profits substantially in the future, meaning a large share of their value to an investor today is derived from expected earnings long into the future. If a firm is growing its profits at a rate of 30% a year, even if those profits are small today, they will be large in several years, so the firm is valuable to investors that believe current growth trends will continue.
One risk to this investment style is that current growth in profit is temporary, so future profits do not live up to expectation. A second risk comes from sensitivity to interest rates – future cashflows have to be discounted to the present, otherwise assets would have infinite value based on projected cashflows going out infinitely into the future. So a rise in interest rates will increase the rate at which future cashflows are discounted, causing growth stocks to typically fall more than value stocks when interest rates rise.
Value stocks are often seen as the contrast to growth stocks. With value stocks you are investing in assets that appear under-priced, or trade at lower prices relative to the company’s dividends, earnings, and sales.
Stocks that exhibit the ‘value’ characteristic derive their value from substantial profits made in the near future, but often with fewer prospects for profit growth in the future. Because less of the value of the stock is derived from cashflows well into the future, when comparing the price paid for the today's profits to growth stocks, value stocks can seem like they are good value, hence the name. Because these stocks derive much of their value from near-term cashflows, they do not get hit by rises in interest rates to the same extent that growth stocks do, however they tend to lag the performance of growth stocks when interest rates fall and when economic growth is very strong.
There’s an ongoing discussion about growth and value stocks and which make better long-term investments. In inflationary times like these certain stocks are bound to do better than others, and because growth stocks set their earnings expectations further into the future, in a high inflation environment it is harder for investors to predict what that future is going to be worth. Whereas, with value stocks investors recoup their money sooner making investments less susceptible to impact from inflation, which makes them more attractive in an inflationary environment.
In the context of inflation, what is key to the two styles of investing is the impact of inflation on interest rates. As mentioned, interest rates have a large effect on the relative performance of growth and value stocks, with falling interest rates benefitting growth stocks and rising interest rates benefiting value stocks. When inflation is high and rising, central banks tend to raise interest rates to rein in inflation, causing value stocks to tend to outperform growth stocks, whereas when inflation is low and falling central banks tend to cut interest rates, causing growth stocks to tend to outperform value stocks. Again, this is all about the level of the discount rate that is applied to the future cashflows that give companies their value, and how long/short term those cashflows are.
Certain things in the short term may look better right now, but with long-term lenses on it’s important to diversify your equity exposure to spread the risk and remain in the market if you want success in your long-term investments.
Mutual Funds is a financial investment that combines assets from shareholders to invest in a group of stocks, bonds, options, or other securities. Mutual funds tend to be actively managed, which means the fund is managed by a team or a manager who make the decisions about how to invest the fund’s money.
Exchange-traded Funds (ETFs)
ETFs merge aspects of mutual funds and conventional stocks, but unlike mutual funds they are traded on stock exchanges and can be bought or sold throughout the trading day at fluctuating prices. ETFs are passively managed which means nobody manages these funds nor makes investment decisions, instead they follow the trends of the market index. Some lines can be blurred in these situations, and it is possible to find actively managed ETFs or passively managed mutual funds, but more often than not they follow the rule of thumb.
There’s a plethora of considerations to make before deciding to invest in assets long-term, and long-term investors need to know that over the course of their investment risks will arise and they need to be able to handle them, but the likelihood is that patience and perseverance in the market will put you on top down the line. To find out more about long-term investing and get some advice on how best to use your funds to reach your goals, why not get in touch for a free initial consultation with one of our financial experts today.
Notes: This article is for general information only and should be taken as individual financial advice. The value of investments can fall as well as rise and you may not get back what you originally invested.