While short-term investing can be highly risky, investing for the long term is a time-honored way to manage certain market risks so you can reach important financial goals, like saving for college tuition and retirement.
That’s because when it comes to building a nest egg for these bigger life expenses, saving alone won’t necessarily get you where you need to go. You need the boost of investment returns over time to help your savings grow. That’s where long-term investing, also called buy-and-hold, comes in.
The chief advantage of a long-term investing strategy is that “time in the market beats timing the market,” as the saying goes. In other words, by sticking to an investment plan for the long term, your portfolio is more likely to weather its ups and downs, and fluctuations in different securities.
That said, long-term investing isn’t a risk-free endeavor, and there are also tax implications for holding investments long term. Knowing the ins and outs can make all the difference to your portfolio over time.
What Is Long-Term Investing?
A long-term investment is an asset that’s expected to generate income or appreciate in value over a longer time period, typically five years or more. Long-term investments often gain value slowly, weathering short- to medium-term fluctuations in the market, and (ideally) coming out ahead over time.
Short-term investments are those that can be converted to cash in a few weeks or months — but they’re generally held for less than five years. Many investors trade these assets in short periods, like days, weeks, and months, to profit from short-term price movements.
However, a short-term investing strategy can be risky and volatile, resulting in losses in a short period.
💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Long-term Investments and Taxes
It’s also worth noting that for tax purposes the Internal Revenue Service (IRS) considers long-term investments to be investments held for more than a year. This is another important consideration when developing a longer-term strategy.
Investments sold after more than a year are subject to the long-term capital gains rate, which is equal to 0%, 15%, or 20%, depending on an investor’s income and the type of investment. The long-term capital gains rate is typically much lower than their income tax rate, which can help incentivize investors to hang on to their investments over the long run.
Why Is Long-Term Investing Important?
Long-term investing can be beneficial for the three reasons noted above:
• Holding investments long term can allow certain securities to weather market fluctuations and, ideally, still see some gains over time. While there are no guarantees, and being a long-term investor doesn’t mean you’re immune to all risks, this strategy may help your portfolio recover from periods of volatility and continue to gain value.
• In the case of bigger financial goals, e.g. saving for retirement or for college tuition, embracing a long-term investment plan may help your savings to grow and better enable you to reach those larger goals.
• Last, there may be tax benefits to holding onto your investments for a longer period of time.
Recommended: Short- vs. Long-Term Investments
10 Tips for Long-Term Investing
So how do you go about establishing a long-term investment plan? These tips should help.
1. Set Goals and a Time Horizon
Your financial goals will largely determine whether or not long-term investing is the right choice for you. Spend time outlining what you want to achieve and how much money you’ll need to achieve it, whether that’s paying for college, retirement, or another big goal.
Once you’ve done that, you can think about your time horizon — when you’ll need the cash — which can help you determine what types of investments are suited to your goals.
For example, if you are saving to buy a car in a couple of years — generally a shorter-term goal — you may consider setting aside money in a savings account, CDs, or money market accounts, which are stable and can provide relatively quick access to your cash.
Stock market investing can be more appropriate for big goals in the distant future, such as saving for a child’s education or your own retirement, which could be 20 or 30 years down the line. This relatively long time horizon not only gives your investments a chance to grow, but it means that you also have the time to ride out market downturns that may occur along the way — which may translate to a better ROI (i.e. a higher return on investment), although there are no guarantees.
2. Determine Your Risk Tolerance
Your risk tolerance is essentially a measure of your ability to stomach volatile markets. It can help you determine the mix of investments that you will hold in your investment accounts — but your risk tolerance also depends on (or interacts with) your goals and time horizon.
Longer time horizons may allow you to take on more risk in some cases, because you’re not focused on quick gains. Which in turn means you might be more inclined to hold a greater proportion of stocks inside your portfolio.
How long should you hold stocks? Generally, holding stocks longer can be beneficial from a tax perspective, and from a risk perspective. The longer you stay invested, the longer you have to recover should markets take a dive.
Setting your risk tolerance also means knowing yourself. If you’re somebody who will be kept up at night when the market takes a downward turn, even if your goal is still 20 years away, then you may not want a portfolio that’s aggressively allocated to stocks. While there are no safe investments per se, it’s possible to have a more conservative allocation.
On the other hand, if short-term market volatility doesn’t bother you, an aggressive allocation may be the best fit to help you achieve your long-term goals.
3. Set an Appropriate Asset Allocation
Understanding your goals, time horizon, and risk tolerance can help give you an idea of the mix of assets — generally stocks, bonds, and cash equivalents — you may want to hold in your portfolio. For example, a portfolio might hold 70% stocks, 30% bonds, and no cash equivalents, depending on the investment opportunities you want to explore.
As a general rule of thumb, the longer your time horizon, the more stocks you may want to hold. That’s because stocks tend to be drivers of long-term growth (although they also come with higher levels of risk).
As you approach your goal, you’ll likely begin to shift some of your assets into fixed-income investments like bonds. The reason for this shift? As you approach your goal — the time when you’ll need your money — you’ll be more vulnerable to market downturns, and you won’t want to risk losing any of your cash.
For example, if the market experiences a big drop, you may be left without enough money to meet your goal. By gradually shifting your money to bonds, cash, or cash equivalents, you can help protect it from stock market swings, so by the time you need your cash, you have a more stable source of income to draw upon.
4. Diversifying Your Investment Portfolio
A key factor of any investing is that portfolio diversification matters. The idea is that holding many different types of assets reduces risk inside your portfolio in the long and short term. Imagine briefly that your portfolio consists of stock from only one company.
If that stock drops, your whole portfolio drops. However, if your portfolio contains stocks from 100 different companies, if one company does poorly, the effect on the rest of your portfolio will be relatively small.
A diverse portfolio contains many different asset classes, such as stocks, bonds, and cash equivalents as mentioned above. And within those asset classes a diverse portfolio holds many different types of assets across size, geographies and sectors, for example.
Different types of stocks
The basic principle behind diversification is that assets in a diverse portfolio are not perfectly correlated. In other words, they react differently to different market conditions.
Domestic stocks for example, might react differently than European stocks should U.S. markets start to struggle. Or investing in energy stocks will be different than tech-stock investing. So, if oil prices drop, energy sector stocks might take a hit, while tech might be less affected.
Many investors may choose to add diversification to their portfolios by using mutual funds, index funds, and exchange-traded funds, which themselves hold diverse baskets of assets.
Recommended: What Is an ETF?
5. Starting Investing Early
This tip may seem like a no-brainer, but increasing your time horizon gives you the opportunity to invest in riskier investments, like stocks, for longer. Though risky, stocks typically offer higher earning potential than other types of investments, such as bonds. Consider that the average stock market return annually is about 10%.
Second, the sooner you start investing, the sooner you are able to take advantage of compound growth, one of the most powerful tools in your investing toolkit. The idea here is that as your money grows, and you reinvest your returns, you steadily keep increasing the amount of money on which you earn returns.
As a result, your returns keep getting bigger and your investments can start to grow exponentially. This phenomenon can also help mitigate inevitable losses.
💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
6. Leaving Emotions Out of It
Investing is just numbers and math, so it’s totally rational, right? Well…not exactly. Humans are emotional creatures and sometimes those emotions can get the better of us, leading us to make decisions that aren’t always in our best interest. Letting emotions dictate our investing behavior can result in costly mistakes, as behavioral finance studies have shown.
For example, if you’re investing in a recession and the stock market starts to drop, you may panic and be tempted to sell your stocks. However, doing so can actually lock in your losses and means that you miss the subsequent rally.
On the other end of the spectrum, when the stock market is roaring, you may be tempted to jump on the bandwagon and overbuy stocks. Yet, doing so opens you up to the risk that you are jumping on a bubble that may soon burst.
There are a number of strategies that can help these mistakes be avoided. First, fight the urge to check how your investments are doing all the time. There are natural cycles of ups and downs that can happen even on a daily basis. These can cause anxiety if you pay attention too closely. You might want to avoid constant checking in and instead keep your eye on the big picture — achieving your long-term goals.
Trust your asset allocation. Remember that your asset mix has already taken your goals, time horizon, and your risk tolerance into consideration. Tinkering with it based on spur-of-the-moment decisions can throw off your allocation and make it difficult to achieve your goals.
7. Reducing Fees and Taxes
Be wary of taxes and fees as these can take a hefty bite out of your potential earnings over time. Also, many investment fees are expressed as a small percentage (e.g. less than 1% of the money you have invested) that may seem negligible — but it’s not.
Also, many investment costs can be hard to find, and thus hard to track. Meanwhile, various expenses can add up over time, reducing your overall gains.
To cover the cost of management, mutual funds and exchange-traded funds charge an expense ratio — a percentage of the total assets invested in the fund each year. An actively managed mutual fund might charge 1.0% or more. A passively managed ETF or index fund may charge 0.50% or less. So you may want to choose mutual funds with the lowest expense ratios, or you may consider passive ETFs or index funds that charge very low fees.
The expense ratio is deducted directly from your returns. You may also encounter annual fees, custodian fees, and other expenses.
You can also be charged fees for buying and selling assets as well as commissions that are paid to brokers and/or financial advisors for their services. It’s important to manage these costs as well. One of the best lines of defense is doing your research to understand what fees you will be charged and what your alternatives are.
8. Taking Advantage of Tax-Advantaged Accounts
There are a few long-term goals that the government wants you to save for, including higher education and retirement. As a result, the government offers special tax-advantaged accounts to help you achieve these goals.
Saving for Education
A 529 savings plan can help you save for your child’s — or anyone’s — college or grad school tuition. Contributions can be made to these accounts with after-tax dollars. This money can be invested inside the account where it grows tax-free. You can then make tax-free withdrawals to cover your child’s qualified education expenses.
Saving for Retirement
Your employer may offer you a 401(k) retirement account through your job. These accounts allow pre-tax dollars to be contributed, which lower your taxable income and can grow tax-deferred inside the account. If your employer offers matching funds, you could try to contribute enough to receive the maximum match. When you withdraw money from your 401(k) at age 59 ½, it is subject to income tax.
You may also take advantage of traditional IRAs and Roth IRAs. Traditional IRAs use pre-tax dollars and allow tax-deferred growth inside your account. Withdrawals at age 59 ½ are subject to income tax.
You fund Roth IRAs, on the other hand, with after-tax dollars, so money in your account grows tax-free, and withdrawals are not subject to income tax.
There are other tax-advantaged accounts that can work favorably for long-term investors, including SEP IRAs for self-employed people, and health savings accounts (or HSAs), in addition to other options.
9. Making Saving Automatic
One way to continually add to your investments is by making saving a regular activity. One easy way to do this is through automation. If you have a workplace retirement account, you can usually automate contributions through your employer.
Or if you’re saving in a brokerage account you can arrange with your broker for a fixed amount of money to be transferred to your brokerage account each month and invested according to your predetermined allocation.
Recommended: What Is a Brokerage Account? How Does it Work?
Automation can take the burden off of you to remember to invest. And with the money automatically flowing from your bank account to your investments accounts, you probably won’t be as tempted to spend it on other things.
10. Checking In on Your Investments
You may want to periodically check in on your portfolio to make sure your asset allocation is still on track. If it’s not, it may be time to rebalance your portfolio. You may want to rebalance when the proportion of any particular asset shifts by 5% or more.
This could occur, for example, if the stock market does really well over a given period, upping the portion of your portfolio taken up by stocks.
If this is the case, you might consider selling some stocks and purchasing bonds to bring your portfolio back in line with your goals. Periodic check-ins can also provide opportunities to examine fees and other costs (like taxes) and their impact on your portfolio.
Investing With SoFi
The most important tips for long-term investing involve setting financial goals; understanding your time horizon and risk tolerance; diversifying your holdings; minimizing taxes and fees; and starting early so your portfolio can benefit from compounding; and understanding how tax-advantaged accounts can be part of a long-term plan.
When you’re ready to invest, whether through retirement accounts, brokerage accounts, by yourself, or with help, these strategies can help you build an investment plan to match your financial situation.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
What is a realistic long-term investment return?
The average historical return of the U.S. stock market is about 10%, but that’s an average over about a century. Different years had higher or lower returns. So asking what a realistic long-term investment return is hard to gauge, and it will ultimately depend on the investments you choose, how long you hold them, as well as the fees and taxes you pay.
Where is the safest place to invest long-term?
All investments come with some degree of risk, but a more secure way to invest for the long term might be with fixed-income securities like bonds, which pay a set return over a period of time. Money market accounts and certificates of deposit (CDs) generally also have fixed rates. But remember that the lower the risk, the lower the return.
What is the biggest threat to long-term investments
Long-term investments, like all investments, are vulnerable to market changes. Even when investing for the long haul, it’s possible to lose money. Another threat is the risk of inflation. As inflation rises, your money doesn’t go as far. So even if you save and invest for decades, inflation is also rising at the same time, and your money may have less purchasing power than you expected.
Photo credit: iStock/Pekic
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