A Basic Look at Long Term Investing
With the recent stock market crash, many people are understandably wary about investing. Concerns about the volatility of the stock market, and the prospect of losses during downturn, have convinced many that stock investing is not for them. However, “safer” investments like cash and bonds may not provide the needed returns for your portfolio to overcome the ravages of inflation. This is where it can help to understand the basic principles underlying long term investing.
Long term investing is big picture
One of the most important aspects of long term investing is that it is big picture. You use long term investing as part of an overall financial plan that helps you reach your goals. Long term investing requires that you consider where you want to be in more than 10 years — and often what you want your finances to look like in 20 or 25 years. Long term investing requires that you try and ignore the ups and downs of what is happening day-to-day on the financial market, and look at overall returns over time. With the stock market, this means reminding yourself that if you have enough time, the stock market will rebound. Over a 25-year period, the stock market has yet to come out behind.
Long term investing requires a certain amount of pickiness
Warren Buffett once advised that you not buy anything that you wouldn’t still want in 10 years. This means that you need to carefully consider your investments. If you are going to hold on to something for more than 10 years, you want it to have solid fundamentals. In the case of individual stocks, this means that you should be looking at items such as capitalization, debt load, management competency, future prospects and earnings. You should not be making a decision based on yesterday’s share price if you want to choose long term investments that are likely to succeed. Do some research and make sure your investments, whether they involve individual stocks, bonds and currencies, or funds and trusts, are suited for riding out the down turns and providing a solid foundation for the future.
Long term investing is usually cost efficient
Whether you tote up your costs due to taxes or to transaction fees, long term investing can be cost efficient. Long term capital gains taxes are lower than those you pay on short term gains. Anything you hold for longer than a year and a day will provide you with lower taxes. Additionally, vehicles like 401k and IRA retirement accounts are geared to be long term investments, and have their own tax advantages. You can also find tax advantages with ETFs and some other types of investments, such as municipal bonds (but be careful; these are riskier than U.S. Treasuries).
Less frequent trading is also an advantage of long term investing. When you make constant trades, your earnings are eaten at through transaction charges. You can reduce your costs by trading less often. Employing a long term investing strategy can also help you avoid the panic selling impulse that grips people during a down market. When you sell while the market is down, you are simply locking in your losses. Adhering to a long term strategy can help you remain focused on the big picture, and help you get more for your money as you buy stocks while they are “on sale.”
Strategies that work well with long term investing
While there is nothing wrong with having some less risky investments in your long-term portfolio, it is important to remember that earning 3% to 5%, on average, from cash and bonds, will not be enough to give you the kind of growth you are looking for long term. Stocks need to be involved as part of your asset allocation in a successful long term investment portfolio. Here are some ideas that can work with a long term investing mindset:
- Index funds: Because they follow indexes, index funds have no need for active management. This means fees are quite low, and your gains mirror the index as a whole, rather than relying on just one company. If you are invested in a fund that focuses on the S&P 500, you will gain over time as the index does. This is true of investments in foreign indexes, small cap indexes and even bond indexes.
- ETFs: Exchange traded funds allow a certain amount of diversity with low fees. You can also diversify across asset classes with funds that focus on commodities, bonds and currencies in addition to those that focus on stocks.
- Dividend investing: If you are looking to get a regular payout, while increasing your portfolio, investing in companies that pay dividends can be a good move. It is also worth noting that many of the companies that offer solid dividends, or that offer regularly increasing dividends, are usually (but not always) fundamentally sound and make good long term investments. You can improve your portfolio growth by making use of a dividend reinvestment plan (DRIP) to buy more shares using what amounts to free money without paying transaction fees.
- Dollar-cost averaging: Investing a regular amount every month gets you in the habit of growing your portfolio, and keeps you investing when stocks are cheaper. Being able to buy partial shares ensures that you are always adding to your portfolio.
In the end, it is vital for you to work out what you want to accomplish with your money, and decide whether a long term investing strategy can work for you.
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i will link to this post in tomorrow’s post on my blog. its convenient because this is exactly what i blog about. i will let you know the moment i do so. i agree with this post as do rich men like warren buffett and the like about investing for the long term
Long-term investing is the way to go.
The problem is that the approach that is widely marketed as long-term marketing is not a long-term approach at all. Passive Investing is short-term investing.
In the long term, the price you pay for stocks determines the return you obtain from them. The most likely long-term return for purchases made at very low valuations is about 15 percent real per year. The most likely long-term return for purchases made at moderate valuations is about 6 percent real per year. The most likely long-term returns at the top of the bubble (when Passive Investing was being marketed most heavily) was a negative number!
To invest successfully for the long term, you need to know what to expect. Are you buying at the sort of price where you are likely to see a negative return, a solid positive return or an astoundingly positive return? Passive Investors can never know this because the entire idea of Passive Investing is to buy stocks at all prices, to invest in ignorance of the effect of price. Passive Investing arguably works to the benefit of The Stock-Selling Industry. It is poison for middle-class investors.
Passive Investing always causes huge financial devastation not only for those who follow it but for the entire economy in which it is promoted. One good thing that we can say about the Passive Investing Era is that it shows that millions of middle-class investors like the idea of long-term investing. I believe that this economic crisis may cause such crushing losses that it will lead to an openness on the part of The Stock-Selling Industry to letting middle-class investors learn about the realities of stock investing and that this may bring in an approach to long-term investing that actually works in the real world.
Rob
Agree, long term investing is the way. Won’t help you in the short run, but will be more safe and give you more peace of mind. It will be more of a security blanket for your future as long as its not too risky.
Long term investing requires hard work and discipline. No one got rich investing in index funds. Passive investing has always been a ticket to mediocre returns. One needs to actively look for businesses that are on sale.
How about that big fund manager speaking publicly he expects the Dow to drop to 6200 this year! Holy Shit!
In our business, we talk about those who’ve lost a lot of money as “long term investors.” Eventually, they’ll get back to even, over the long term!
I’d be very wary of putting new money in the stock market now.
FS
When the market crashed and rebounded, some were talking about market timing being a good addition to long-term investing. However, market timing as never proven to win out in the long term. Only proper asset allocation does. – As for dollar cost averaging, this is also a good strategy. You picked up a few cheap shares about 9 months ago that have appreciated quite nicely. – Thanks for summarizing for us why long-term investing is still the way to go!
I whole-heartedly agree with the strategies for long-term investing ie investing in ETFs and Index funds for the average investor.
If you look at Warren Buffets trading record recently (past 10 years), he has been churning his portfolio (public record). When he sells, he doesn’t sell his entire position. He cuts it down and reallocates it into other parts of his portfolio or something new.
Zen