What Are Long-Term Investments?

Not an asset class but rather a perspective, long-term investments involve taking more risk in the short-term to realize long-term returns by buying and holding diversified securities for years.
Alieza Durana
By Alieza Durana 
Updated
Edited by Chris Davis

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Nerdy takeaways
  • A long-term investor takes more risks in the short term to reap potential long-term returns.

  • Generally, holding an investment for at least five years differentiates long-term investments from short.

  • You pay long-term capital gains taxes upon the sale of long-term investments.

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 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. It 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 takes more risks in the short term to reap potential long-term returns. For instance, a person with 30 years until retirement may put most or all of their portfolio in diversified stocks like index funds or exchange-traded funds (ETFs). In contrast, someone five years away from retirement might want a lower-risk short-term investment.

Long-term investment examples

All assets carry risk; with stocks, the risk is price volatility, meaning that prices bounce around. When the price of individual stocks falls, 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, but may come with penalties for withdrawing early. For example, you’ll most likely pay a penalty to access the money before age 59 ½ with an Individual Retirement Account (IRA). 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, it’s historically averaged out to a gain over the long term. If you plan 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

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.

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.”

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 may only be held for 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 critical 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.

In contrast, short-term investments 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.

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Selecting a long-term investment

Considering a long-term investment and trying to figure out 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 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.

Never fear 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, 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, and anything that lets you set it and forget it.

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