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Investing for the long term is a time-honored way to help manage certain market risks so you can reach financial goals, like saving for a downpayment on a house and retirement.
When it comes to building a nest egg for bigger life expenses, saving alone may not get you where you need to go. If this is the case, the boost of potential investment returns over time may help you reach your savings goal. That’s where long-term investing, also called buy-and-hold, comes in.
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.
Key Points
• Long-term investing focuses on longer-term goals like education, buying a home, and retirement.
• Starting investing early helps increase the potential benefits of compound growth and market returns.
• Understanding risk tolerance can be helpful in choosing the right mix of investments.
• Automating contributions can make saving and investing easier.
• Reducing fees and using tax-advantaged accounts can enhance long-term returns.
10 Tips for Long-Term Investing
An 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.
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 your child’s college tuition, 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, stock market investing can be 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 or more 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. That may translate to a more favorable 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 may choose for your portfolio. 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, for example.
How long should you hold stocks? Generally speaking, holding stocks longer could be beneficial from a tax perspective, and from a risk perspective. Theoretically, 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 won’t be able to sleep 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, a more aggressive allocation may be an option 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 an idea of the mix of assets, such as stocks, bonds, and cash equivalents you may want to hold in your portfolio.
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 may want to consider shifting some of your assets into fixed-income investments like bonds. The reason for this shift? As you get closer to the time when you’ll need your money, you’ll be more vulnerable to market downturns, and you may not 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 like CDs or a money market account, you can help protect it from potential stock market swings. That way, by the time you need your cash, you may have a more stable source of income to draw upon.
4. Diversifying Your Investment Portfolio
A key factor of investing is portfolio diversification. The idea is that holding many different types of assets helps reduce 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 generally 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 from 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 ETFs, which themselves hold diverse baskets of assets.
5. Starting Investing Early
Increasing your time horizon gives you the opportunity to invest for longer. Take stocks, for example. 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% (or 7% when adjusted for inflation).
Second, the sooner you start investing, the sooner you are able to take advantage of compound growth, one of the most potentially 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 may keep getting bigger and your investments could start to grow exponentially.
💡 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
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 during 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 a potential 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 constantly check how your investments are doing. There are natural cycles of ups and downs that can happen even on a daily basis. To help reduce potential anxiety, you might want to avoid constant checking in and instead keep your eye on the big picture of achieving your long-term goals.
Tinkering with your asset allocation based on emotions and spur-of-the-moment decisions can throw off your allocation and make it difficult to achieve your goals.
7. Reducing Fees and Taxes
Taxes and fees can take a hefty bite out of your potential earnings over time. 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 track. Meanwhile, various expenses can add up over time, reducing any overall gains.
Expense ratios
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 0.75% or more. A passively managed ETF or index fund may charge an average of 0.12%. 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.
Advisory fees
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 generally encourages 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 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 you to contribute pre-tax dollars, 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 or later, 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. You pay tax on withdrawals in retirement.
Roth IRAs are funded 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
You can continually add to your investments 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.
If you’re saving in a brokerage account you can set it up so that a fixed amount of money is transferred to your brokerage account each month and invested according to your predetermined allocation.
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.
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.
💡 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.
What Is Long-Term Investing?
Long-term investing is a strategy of investing for years. 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. Some investors trade these assets in short periods, like days, weeks, or months, to profit from short-term price movements.
However, a short-term investing strategy can be highly risky and volatile, resulting in losses in a short period.
Long-term Investments and Taxes
It’s also worth noting that for tax purposes, the 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 may 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, such as 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.
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, starting early so your portfolio can benefit from compounding, and understanding how tax-advantaged accounts can be part of a long-term plan.
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), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What is a realistic long-term investment return?
A realistic long-term investment return will ultimately depend on the investments you choose, how long you hold them, as well as the fees and taxes you pay. To give some perspective, the average historical return of the U.S. stock market is about 10% (or 7% with inflation taken into account), but that’s an average over about a century. Different years had higher or lower returns.
Where is the safest place to invest long-term?
All investments come with some degree of risk. One lower-risk 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, there is always some risk involved. Also, generally, 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, if inflation is also rising at the same time, your money may have less purchasing power than you expected.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Dollar Cost Averaging (DCA): Dollar cost averaging is an investment strategy that involves regularly investing a fixed amount of money, regardless of market conditions. This approach can help reduce the impact of market volatility and lower the average cost per share over time. However, it does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals, risk tolerance, and market conditions when deciding whether to use dollar cost averaging. Past performance is not indicative of future results. You should consult with a financial advisor to determine if this strategy is appropriate for your individual circumstances.
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