When it comes to big savings goals like college tuition and retirement, many investors turn to long-term investing. Yet financial markets can be a turbulent, scary place, and it can be useful to have some guidance to how to navigate day-to-day market fluctuations.
10 Tips for Long Term Investing
Here are 10 tips that aim to help you reach your long-term investment goals.
1. Setting Goals and a Time Horizon
What your goals are will largely determine whether or not long-term investing is the right choice for you. So you might want to spend time outlining what you want to achieve—which may depend on your life stage—and how much money you’ll need to achieve it.
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 better suited to your overall goals. Investing in the stock market is generally a long-term proposition, which may not always be appropriate for shorter-term goals.
For example, if you are saving to buy a car in just a couple years, you may consider setting aside money in a savings account or money market accounts, which are stable and can provide relatively quick access to your cash.
If you were to invest the same money in the stock market, you are subject to greater market risk, meaning markets could be down when you need to pull out your cash. The short timeframe of your goal allows little time to recover from a downswing.
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.
2. Determining Your Risk Tolerance
Your risk tolerance is essentially a measure of your ability to stomach weak markets. It can help you determine the mix of investments that you will hold in your investment accounts.
Your goals and time horizon will play a part in determining your risk tolerance, as will your personal level of comfort. Longer time horizons typically mean that you can have a higher risk tolerance, which in turn means you might be more inclined to hold a greater proportion of stocks inside your portfolio.
This goes back to the idea that the longer you have to stay invested, the longer you have to recover should markets take a dive. A shorter time horizon means you may prefer to hold a greater proportion of less risky assets like bonds, cash or cash equivalents. These tend to be less volatile, so if the market drops, they are unlikely to drop with it.
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. On the other hand, if stock market volatility doesn’t bother you, an aggressive allocation may be the best fit to help you achieve your long-term goals.
3. Setting an Appropriate Asset Allocation
Understanding your goals, time horizon and risk tolerance can help give you an idea of what 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.
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.
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 likely become more vulnerable to market downturns.
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 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.
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.
5. Starting Investing Early
This tip may seem like a no-brainer, but there are very good reasons to start investing as early as you can for long-term goals. First, this can give yourself time to ride out market volatility, as mentioned above.
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 compounding interest, one of the most powerful tools in your investing toolkit. Compound interest is essentially the interest you earn on your interest.
The idea here is that as you reinvest your returns, you are 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.
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.
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 stocks 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 it 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.
Mutual funds are a common, actively managed tool for investing. To cover the cost of management, mutual funds may charge an expense ratio—a percentage based on the total assets invested in the fund each year. The expense ratio is deducted directly from your returns. You may also encounter annual fees and custodian fees.
You can also be charged fees for buying and selling assets as well as commissions that are paid to brokers for their services. It’s important to manage these costs, as they can eat away at your ability to save over time. One of the best lines of defense is doing your research to understand what fees you will be charged and what your alternatives are.
For example, 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. Selling stocks can expose you to short-term or long-term capital gains tax. Short-term capital gains tax—which is equal to your income tax rate—is owed when a stock is sold after being owned for a year or less.
Long-term capital gains tax—equal to 0%, 15% or 20%, depending on the tax bracket—is owed on assets that are sold after they’ve been held for a year or more. Limiting how often stocks are sold may limit the amount of capital gains taxed owed.
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.
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.
Your employer may offer you a 401(k) 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.
IRAs provide more flexibility in terms of investment options than 401(k). Usually 401(k)s offer limited investment options through your employers, whereas you can hold diverse investments from stocks and bonds to real estate inside an IRA.
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.
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 and their impact on your portfolio.
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.
The most important tips for long-term investing involve setting financial goals, diversifying your holdings, learning about taxes and fees, and starting early so your portfolio can benefit from compounding. This plan accounts for your individual needs, and sticking to it can help you achieve your long-term objectives.
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