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When Walnut Creek, California-based certified financial planner Mario 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 critical in deciding where to place money. So one of the first things to consider is how soon you want your nest egg.
Long-term investments are not an asset class but rather an approach to investing that focuses on long-term gains despite potential short-term volatility.
"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."
A long-term investor takes 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 such as index funds or exchange-traded funds. In contrast, someone five years away from retirement might want a lower-risk, short-term investment.
Retirement accounts are, by definition, long-term investments. For example, with an individual retirement account, you'll most likely pay a penalty to access the money before age 59½. If you're investing outside of an IRA or 401(k), you can still have that mindset by investing in diversified funds and holding them for the long term, but keep in mind you won't receive the same tax advantages that retirement accounts provide.
» Not sure what an index fund is? Learn more about this easy way to enter the stock market
Long-term investment examples: ETFs, index funds and mutual funds
All assets carry risk, and with stocks, the risk is price volatility, meaning that prices bounce around. When the prices 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 Allison Alexander, a Rockford, Illinois-based certified financial planner.
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, it's historically averaged out to a gain over the long term. So if you're planning to hold for the long-term, short-term volatility won't be as much of a concern. As a result, diversified funds such as index funds and exchange-traded funds could be considered long-term investments.
Like 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, risks and yields. 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.
According to Hernandez, patience can lead to investing success over time.
"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
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 several 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.
The 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, 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 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
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 it offers 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 and a broad range of investments — anything that lets you set it and forget it.
» Learn more about how to open a brokerage account