Long-Term Investments Definition - NerdWallet (2024)

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Long-term investments definition

Long-term investments are not an asset class, but rather an approach to investing that focuses on seeking long-term gains despite potential short-term volatility.

In practical terms, a long-term investment is one you hold for at least a year, and for which you pay long term capital gains taxes upon sale (according to the IRS). But there are more ways to think about long-term investments than how the IRS defines them. While the exact time range of a long-term investment varies from investor to investor, holding for at least five years is considered typical and differentiates long-term investments from the purpose of short term investments and cash in a portfolio.

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Who is a long-term investor?

A long-term investor is a person taking more risks in the short-term to reap potential long-term returns. For instance, a person with 30 years until retirement might do well to put most or all of their portfolio in diversified stocks like index funds or exchange-traded funds (ETFs), whereas someone who is five years away from retirement might want a lower-risk short-term investment.

Long-term investment examples

All assets carry risk, and with stocks, the risk is price volatility, meaning that prices bounce around. When the price of individual stocks fall, there's no guarantee they'll recover. Or, if you sell too early, you won’t benefit from a price recovery.

“Long-term investments are more of a mindset than a specific investment type," says Rockford, Illinois-based certified financial planner Allison Alexander.

Investing in diversified funds and holding them for the long-term can offer the benefits of long-term investing.

Retirement Accounts

Retirement accounts are by definition long-term investments and provide particular tax advantages, as well as penalties for withdrawing early. For example, with an Individual Retirement Account (IRA) you’ll most likely pay a penalty to access the money before age 59 1/2. If you’re investing outside of an IRA or 401(K), investing in funds through a brokerage account can offer similar benefits.

ETFs, index funds and mutual funds

For diversified stock funds, the risk tends to be limited to short term volatility. Take an index fund pegged to the S&P 500 as an example. Even though the fund has up and down years, over the long-term, it’s historically averaged out to a gain. If you’re planning to hold for the long-term, this short-term volatility won’t be as much of a concern. As a result, diversified funds such as index funds and exchange-traded funds (ETFs) could be considered long-term investments.

» Not sure what an index fund is? Learn more about this easy way to enter the stock market

Risks and rewards of bond funds

Similar to stock ETFs, bond market funds are bundles of bond investments offering easy diversification and exposure to the bond market. Bond funds, like bonds, can have different maturities, risk and yield. Bond funds with longer maturities (like 30 years) have higher yields and could be considered a long-term investment, but not for the same reason as stocks. Longer-term bonds pay higher yields because there's a higher risk of inflation eating into your fixed interest payments.

However, the risk and reward profile of bonds with longer maturities might not stack up with the risks and rewards of investing in stocks:

“We're not interested in long term or high yield [bonds], because that offers an element of risk that you're not necessarily rewarded for. Our attitude is if you're going to take risk, you'll be better rewarded for it on the equity side of the portfolio," says Alexander.

Ultimately, having patience can lead to investing success over time, says Walnut Creek, California-based certified financial planner Mario Hernandez.

“Not every asset is going to do well every year. Investments aren’t meant to. If you bail out and go into cash, you’ll realize that loss, and you won’t be able to participate in the rebound in the market.”

» Learn more about mutual funds, what they are and how to invest

Long-term investment vs. short-term investment examples

The difference between long-term and short-term investments is time: A long-term investment could be held for five years, 10 years, 30 years or more, whereas short-term investments might only be held in a range of a few months to a few years.

When Hernandez meets with clients, he starts by asking them about their goals and time horizon. No matter where you are on your investment journey, time is a critical factor in deciding where to place money. One of the first things to consider is how soon you want your nest egg.

“Everything you invest in is risky,” says Hernandez. “It’s a matter of perspective – less versus more risky – but in all cases there’s a level of risk.”

Generally, it’s a good idea to spread investments across a range of assets and own a range of investments within each asset class (like stocks, bonds, cash, etc.) to be diversified, thereby placing your financial eggs in a number of baskets.

“You shouldn't be invested in only one type of investment, like stocks or bonds or real estate. If you're going to plan for retirement, then you have to have enough resources and flexibility in different types of assets to know you’ll be ok and comfortable,” says Hernandez.

Money you want to access quickly, like an emergency fund, may be best stored in cash, such as in a high yield savings account or a money market account that allows your money to be readily available.

Short term investments, in contrast, act as a savings or income vehicle for an investing goal of a specified period, say one year.

Short term bond funds are considered an option for money you may need in two to three years. Composed of short-term loans to companies or governments (rather than equity), short term bond funds tend to be less risky than stocks, especially when backed by the credit of municipalities or the U.S. government.

Insured bank certificates of deposit (CDs) are considered a risk-free investment option for money you need in three to five years, as long as you don’t withdraw the money early and pay a penalty.

» Learn more about how to invest savings for short-term or long-term goals and low-risk investment options.

Long-Term Investments Definition - NerdWallet (4)

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Selecting a long-term investment

Considering a long term investment and not sure where to start? If your employer offers a 401(K), taking part is a great place to start, especially if they offer to match your contributions.

If you don’t have access to a 401(K) or are already contributing up to the match amount, you could consider opening and funding an IRA. Once you have an IRA or 401(K) account, increasing your contribution can be a convenient way to access the stock market.

If you don’t have access to a 401(K) or aren’t ready to open an IRA, never fear. You can still access ETFs, index funds and mutual funds through brokerage accounts, but it’s important to remember you’ll forgo the tax benefits of retirement accounts. As you consider a broker, look for one with low fees, a broad range of investments, anything that lets you set it and forget it.

» Learn more about how to open a brokerage account

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Now, let's dive into the concepts mentioned in the article you provided.

Long-term Investments

Long-term investments are an approach to investing that focuses on seeking long-term gains despite potential short-term volatility. They are not an asset class but rather a strategy for holding investments for an extended period. According to the IRS, a long-term investment is one that is held for at least a year and for which long-term capital gains taxes are paid upon sale.

The exact time range of a long-term investment can vary from investor to investor, but holding an investment for at least five years is considered typical. This duration differentiates long-term investments from short-term investments and cash in a portfolio.

Long-term Investors

A long-term investor is someone who takes more risks in the short-term to reap potential long-term returns. For example, a person with 30 years until retirement might choose to put most or all of their portfolio in diversified stocks like index funds or exchange-traded funds (ETFs). On the other hand, someone who is five years away from retirement might opt for a lower-risk short-term investment.

Long-term Investment Examples

There are various examples of long-term investments:

  1. Retirement Accounts: Retirement accounts, such as Individual Retirement Accounts (IRAs) and 401(K)s, are by definition long-term investments. They provide particular tax advantages and may have penalties for early withdrawal.

  2. ETFs, Index Funds, and Mutual Funds: Diversified stock funds, such as index funds and ETFs, can be considered long-term investments. While they may experience short-term volatility, over the long-term, they have historically averaged out to a gain.

  3. Bond Funds: Bond market funds, similar to stock ETFs, offer easy diversification and exposure to the bond market. Bond funds with longer maturities, such as 30 years, could be considered long-term investments. However, the risk and reward profile of longer-term bonds may not stack up with the risks and rewards of investing in stocks.

Long-term Investment vs. Short-term Investment

The main difference between long-term and short-term investments is the time horizon. Long-term investments are held for a longer duration, typically five years, 10 years, 30 years, or more. Short-term investments, on the other hand, are held for a shorter range, ranging from a few months to a few years.

When deciding where to place money, it's important to consider the time horizon and goals. Spreading investments across a range of assets and owning a variety of investments within each asset class can help diversify the portfolio and manage risk.

Selecting a Long-term Investment

If your employer offers a 401(K), participating in it is a great place to start, especially if they offer to match your contributions. If you don't have access to a 401(K) or are already contributing up to the match amount, you could consider opening and funding an IRA. Increasing your contribution to an IRA or 401(K) account can be a convenient way to access the stock market.

If you don't have access to a 401(K) or aren't ready to open an IRA, you can still access ETFs, index funds, and mutual funds through brokerage accounts. However, it's important to note that you'll forgo the tax benefits of retirement accounts in this case. When choosing a broker, look for one with low fees, a broad range of investments, and features that suit your needs.

I hope this information helps you understand the concepts mentioned in the article. If you have any further questions or need more information, feel free to ask!

Long-Term Investments Definition - NerdWallet (2024)
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