Accumulating wealth for financial goals such as funding your retirement or your children’s college education is generally a long-term proposition that requires a commitment to saving and investing over time. Many financial experts suggest that before you decide how to invest money long-term, you build a sufficient emergency fund. After that, you can explore investments for your longer-term financial goals.
Types of Long-Term Investments
Consider the advantages and disadvantages of investments available to you, and factor in your time horizon, risk tolerance and investment objectives. Here are seven types of long-term investments that are often used by investors to achieve financial goals:
Stocks represent ownership in a company, and shareholders invest with the expectation that the company will continue to grow, causing the share price to increase.
Over the longer term, investing in stocks has been an effective way to accumulate wealth. For example, a hypothetical $100 invested in the Standard & Poor’s 500 index on Jan. 1, 1928, would have been worth $399,885.98 by the end of 2017. That’s not to say that stocks go up all the time — quite the contrary: The S&P 500 lost 38.5 percent in 2008, the peak year of the financial crisis.
Individual stocks can be a great source of wealth. For example, on Dec. 31, 2002, one share of Apple (AAPL) stock sold for $1.02 on a split-adjusted basis. Apple closed on March 2, 2018, at $176.21 per share. Knowing how to invest in stocks, however, is a difficult field to master. Even with strong companies selling popular products, the stock market can be unpredictable.
Pros of investing in stocks: Over time, stocks can be a great source of wealth.
Cons of investing in stocks: Mastering the knowledge to buy and sell profitably is difficult in this unpredictable field. Individual stocks carry the full business risk associated with the company.
Check this out: 9 Safe Investments with High Returns
2. Interest-Paying Bonds
Unlike stocks, which represent ownership in the underlying company, bondholders are creditors of the issuer — meaning that those holding the bonds are lending money to the issuer. Bonds are purchased with the expectation that bondholders will receive regular interest payments, usually semi-annually, and then will receive the face value of the bond — usually $1,000 — when the bond is redeemed.
Generally, bonds can be bought or sold on the secondary market, though the price might be higher or lower than the price that you originally paid for the bond. The price of a bond moves inversely with interest rates. In other words, when interest rates increase, the price of a given bond will decrease. For investors who plan to hold on to their bonds until maturity, this will not have too much of an impact.
Other factors to consider when looking at individual bonds include the credit quality of the issuer and the time until the bond matures. The longer a bond has until it matures, the greater the impact a change in interest rates will have on its price. Bonds are generally less volatile than stocks and often don’t move in the same direction as stocks, so they can be a good diversifier in an investment portfolio.
Pros of investing in bonds: Good diversification from stocks and regular income
Cons of investing in bonds: Price can drop in periods of rising interest rates
3. Zero-Coupon Bonds
With a zero-coupon bond, you still receive the face value of the bond at maturity — typically, $1,000 — but you won’t receive any interest payments. When you buy a zero-coupon bond, you pay a discounted price, such as $600. Every year, the price of that bond trends higher, until it finally pays off at maturity.
One factor to consider with zero-coupon bonds is their “phantom taxation.” Although you never receive interest payments, you’ll owe tax on the appreciation of the bond every year. For this reason, it’s advisable to keep zero-coupon bonds in a tax-deferred account or to buy tax-free zero-coupon bonds issued by municipalities.
Zero-coupon bonds can be a good choice for long-term investment because you know exactly the amount of money you’ll receive in the future. For example, if you know that in 20 years you’ll need $40,000 to pay for your child’s college, you can buy $40,000 in face value of zero-coupon bonds now. As of March 5, 2018, you’d pay roughly $548 per bond, for a total cost of $21,920. When the time arrived in 2038 to pay those college expenses, you’d have $40,000 waiting for you.
Although some corporations might offer zero-coupon bonds, the safest bet is to buy zeros issued by the U.S. government. Like all government bonds, zero-coupon bonds, also known as STRIPS, are backed by the full faith and credit of the U.S. government and are considered to have extremely low risk of default.
Pros of investing in zero-coupon bonds: Certainty of future returns; low default risk in government STRIPS
Cons of investing in zero-coupon bonds: Phantom taxation occurs if used in a regular investment account; no interest until maturity
Stocks and Bonds: How to Choose the Best Investments
4. Mutual Funds
Mutual funds invest in stocks, bonds or other types of investments. Mutual funds offer a diversified portfolio that is either actively managed by a professional investor or is a passively managed index fund, where the fund attempts to replicate the performance of an index such as the S&P 500.
The advantage of mutual funds is that even a small investor can purchase an investment holding a number of different stocks or bonds, providing instant diversification. Index funds, in particular, provide a low-cost way to invest compared with most actively managed funds, which can suffer from high fees and manager underperformance. In 2017, for example, only 43 percent of active fund managers outperformed their passively managed peers, and that was a major improvement from the 26 percent that accomplished the feat in 2016.
Factors to consider for all mutual funds include costs. Be wary of mutual funds that assess a sales charge or front-end load. For actively managed funds, understand who is managing the fund and what their track record is.
Pros of investing in mutual funds: Easy way for small investors to invest in a portfolio of stocks or bonds with a relatively small investment
Cons of investing in mutual funds: High expense ratios and mediocre performance generally associated with actively managed funds
Read More: Mutual Funds – Everything You Need To Know
5. Exchange-Traded Funds
Exchange-traded funds are similar to mutual funds in many respects. The major difference is that ETFs can be traded any time the market is open, just like a stock.
ETFs typically track popular segments of the stock market and mainstream market benchmarks. These and other popular index ETFs offer low-cost exposure to a portion of the stock market. Other popular index ETFs track indexes for various parts of the U.S. and foreign stock markets and the domestic and foreign bond markets, as well.
Most brokerage firms charge a commission to trade ETFs, though a number of brokers — including Charles Schwab, Fidelity and TD Ameritrade — offer a menu of no-transaction-fee ETFs. Vanguard account holders can trade Vanguard’s ETFs with no transaction fees.
ETFs can be a great, low-cost way to invest, but as with any investment, you need to understand what you are buying and why you are investing there.
Pros of investing in ETFs: Low-cost, transparent investment vehicle; tax efficiency
Cons of investing in ETFs: Many new ETFs based on questionable benchmarks with unproven market performance
6. Alternative Investments
Alternative investments are investments that fall outside the realm of traditional long-only stocks, bonds and cash. For example, an alternative investment might bet against the stock market via a position known as a short trade, or it might own more exotic investments such as gold, commodities or cryptocurrencies.
Traditionally, these have only been available to accredited investors who meet certain income and net-worth requirements, and institutions, such as foundations, endowments and pension funds. In recent years, many alternative strategies have become more widely available as mutual funds and ETFs with fewer purchase restrictions.
Alternative investments can add diversification to a portfolio and can dampen portfolio volatility. Whether you’re buying investments via mutual funds, ETFs or hedge funds, as an investor you should always understand what you’re investing in, the fees and expenses involved, and any restrictions or lock-ups associated with these alternative products.
Pros of investing in alternative investments: Can add another level of diversification to an investment portfolio
Cons of investing in alternative investments: Might be difficult to understand, with high fees and expenses
7. Retirement Accounts
Retirement accounts are not a type of investment, like the others listed above, but rather, a type of account in which you can buy stocks, bonds, mutual funds, ETFs and other investments. Retirement accounts are included on this list due to their long-term nature, as you can’t generally access your money in a retirement account without paying a 10 percent penalty until you’re at least 59.5 years old.
For a personal account, you can open either a traditional or a Roth individual retirement account. The former can offer the opportunity to contribute on a pretax basis if you meet certain income requirements.
Money invested within a traditional IRA grows tax-free but is taxed when withdrawn, except for the value of any after-tax contributions. Roth accounts are funded with after-tax dollars, but for the most part, the money can be withdrawn tax-free. You’re not eligible to contribute to a Roth IRA, however, if your income is above a certain level.
Workplace retirement plans, such as a 401k, a 403(b), a 457, or the government’s Thrift Savings Plan, are called “defined contribution plans.” For all of these plans, workers might contribute a percentage of their salary. Available investments are usually in the form of mutual funds, and in some cases, employers will match a certain percentage of employer contributions.
All of these retirement accounts are geared toward socking away long-term money for retirement purposes.
Pros of investing in retirement accounts: These accounts are a great way to save for retirement on a tax-deferred basis.
Cons of investing in retirement accounts: Some 401k plans offer sub-par investment menus with high fee structures; most accounts prevent access until age 59.5 or older.