The benefits of long-term investments
Long-term investments may not be as exciting as short-term plays, but they tend to be less risky and they can certainly pay off handsomely in the end. Find out what the best long-term investments are, and how you can benefit.
What is long-term investment?
One of the greatest thrills of short-term investments is pocketing a big return as a reward for choosing the right stock, bond or fund. However, once you’ve collected your return, you’re still left with the capital, and the next investment you make may not be so successful.
Long-term investments may not be as exciting, but they tend to be a lot less risky. And if you choose wisely, you could still benefit from the odd dividend from time to time. By investing for the long-term, you are committing to your investments, and history has shown that this strategy can pay off handsomely.
For instance, if you had invested in a FTSE 100 tracker fund on 1 January 2008, you would have lost 24.59% by the end of the year. A disaster for short-term investors, but a blip for the long-term player. By December 2014, the stock market was up by 11.67% from January 2008 — not bad for a six-year bet, especially when you consider that the UK base interest rate was just 0.5% at the time, and banks were offering record-low returns on their savings accounts and Cash ISAs.
The savvy investor knows that markets can be volatile, but if you put your money in a solid, well-regulated investment, it will almost always hold or increase its value over time. Just as long as you know when to hold your investment, and when to cash out.
Three benefits for long-term investing
1. Cashing out
This is the part which makes people nervous. How do you know when to cash out your investment, and when to hold? There is no easy answer to this, as markets can rise and fall on an hourly basis and often act unpredictably. Earlier this year, trading volumes on the FTSE 100 neared an all-time high, yet just a few months previously, the Brexit vote was wreaking havoc with daily trading.
Unless you have a crystal ball, there is no way to predict the best time to cash out, and you will drive yourself mad trying to anticipate market moves.
Instead, set yourself an investment goal and stick to it. This might mean that you cash out once your gains hit double figures, or maybe you have a particular date in mind (for instance, your retirement), or you want to hit a specific amount to pay for your child’s education or a new car.
The key is to remove emotion from the equation, set a goal and stick to it. Most retail investors will get understandably nervous when their funds start suddenly dropping in value, but resist the temptation to pull your money in an effort to avoid further losses. You’re in it for the longer term and markets always rise and fall in the short term.
2. Compound interest
One of the major benefits of long-term investing is the ability to make substantial gains through compound interest.
For the long-term investor, compound interest is basically free money. Each year, all being well, you will receive some sort of return on your initial investment. Re-invest this and you will increase the amount of interest which you can receive the following year. Each year, by continuing to re-invest your interest you are growing your capital, and the longer you do this the more money you can make. For example, if you invested £1000 in year one and took a return of 10%, you would have increased your capital to £1100. By the end of year two, that 10% would be worth £110. Reinvest this and by year three 10% would mean £121.
By simply reinvesting your annual interest, within three years you would have made an overall return of more than 20% on your original investment.
3. Delayed taxation
There is another great reason to invest for the long-term — lower taxes.
If you are in it for the long term, you may avoid a lot of taxation by withdrawing your investment after retirement, when your annual income drops below the higher tax rate bands. Many retirees find themselves in the lower tax bracket (20% on any earnings of between £11,001 and £43,000). This means that any annuities from your long-term investments will be taxed at a lower rate — and you could avoid taxation altogether if you have invested through a tax-free wrapper such as a stocks and shares ISA.
Patience pays. If you can afford to lock your money away for a prolonged period of time, you will maximise your chances of getting a handsome return. Just make sure that you follow the golden rules of investing: understand your risk profile, diversify your stock portfolio, and hold your nerve.