Long-Term Investments: Overview, Advantages, Strategies
What are Long-Term Investments?
Long-term investments are assets that an individual or company intends to hold for a period of more than three years. Instruments facilitating long-term investments include stocks, real estate, cash, etc. Long-term investors take on a substantial degree of risk in pursuit of higher returns.
Long-term investments are not subject to any adjustments due to temporary market fluctuations. However, such investments may be written down to reflect declining market value.
Advantages of Long-Term Investing
Long-term investing is likely to lead to meaningful wealth creation in the long term. Many individuals who lack the expertise required to participate in derivative markets depend on long-term investment returns to plan their financial future. It may include dividend income from shareholding and interest received on fixed deposits.
1. Less time-consuming
Long term investing is less time-consuming as investors need not monitor markets for small fluctuations on a daily basis.
2. Lower transaction fees
Brokerage fees and capital gains taxes form a majority of the costs of investing, excluding the risk factor. Long-term investors are subject to transaction fees less frequently, if not at a lower rate, than short-term investors. Many investors are able to allow returns to compound in their bank accounts while deferring capital gains taxes. Capital gains taxes are also charged at a lower rate than short-term profits.
Strategies for Long-Term Investments
1. Current income strategy
The current income strategy includes a range of allocation decisions aimed at identifying established entities that provide above-average distributions without the risk of default, such as large-cap and blue-chip equities. It is best suited for an investor looking for a relatively steady and consistent strategy.
To identify suitable companies, the investor must focus on the major drivers of long-term shareholder returns. They include a business’s competitive advantage, its growth prospects, and the competence of its management team rather than quarterly reports and stock prices. Characteristic symptomatic of a good investment opportunity include:
- Companies with a substantial history of steady or consistently increasing dividend: Rare events often cause temporary downturns in a company’s stock prices. Such occurrences are common in the oil industry, which is extremely sensitive to changes in geopolitical situations. It, however, does not impact the company’s dividend-paying capacity permanently. Contrarily, it presents a buying opportunity rather than a threat to long-term investors.
- Companies operating in low changing industries with growing income prosperity: It means that as incomes and populations grow, people are more likely to spend on goods in such industries. They include industries in consumer staples, such as food and beverages and healthcare.
2. Capital growth strategy
The capital growth strategy aims to maximize the appreciation of all the securities in the portfolio over a period of 10 years or more. Such portfolios may comprise equities and packaged products such as exchange-traded funds (ETFs) and mutual funds. Such a strategy can include a diverse mix of securities depending on the risk appetite of individuals.
Usually, maximum capital appreciation is only achievable through aggressive allocation, which is highly risky. Investors usually select target-date funds, as the primary goal of the investment is to fund college educations or retirement plans. They can be aggressive in the beginning, and as the target date approaches, they become more conservative.
3. Balanced investment strategy
The balanced investment strategy is aimed at combining investments in a portfolio such that the risks and returns are evened out. Typically, stocks and bonds make up equal percentages of the holding of such a portfolio. Such a strategy is most suited to investors with medium risk appetite.
On the capital preservation side, they include low yielding but safe instruments such as high-grade bonds and stocks that pay steady dividends. On the other hand, riskier but higher-paying stocks, such as preference shares, and equities in companies with low market capitalization and credit ratings, are included. They represent the aggressive capital growth aspect of balanced strategies.
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Article initially published on corporatefinanceinstitute.com
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