Making money is one thing. Making your money make more money over time through smart investments, however, is something that will take a little more planning–and, of course, lots of time. Accumulating wealth for financial goals such as funding your retirement or your children’s college education is 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.
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 long term, investing in stocks has been one of the primary drivers of wealth creation. For example, a hypothetical $100 invested in the Standard & Poor’s 500 index on Jan. 1, 1928, would have been worth $223,029.45 by January 2021. Those gains were made in spite of not only the S&P 500’s 38.5 percent collapse in 2008, but the Great Depression, and every downturn in between.
Benefits and Drawbacks of Stocks
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. On March 1, 2021, the same stock was trading at about $121 per share. Knowing how to pick stocks, however, is a difficult craft 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.
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.
Benefits and Drawbacks of Interest-Paying Bonds
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.
Benefits and Drawbacks of Zero-Coupon Bonds
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 1, 2021, you’d pay a total cost of $22,147. When the time arrived in 2041 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 a near-zero 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
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. With the arrival of the index fund era, however, expensive, actively managed mutual funds are becoming harder and harder to justify.
Benefits and Drawbacks of Mutual Funds
Barrons, the New York Times, and Forbes are just a few of the publications that continue to document the failure of mutual funds in general to beat the major indices or much cheaper index funds that track them. Over time in both bull and bear markets, less than half of all mutual funds beat the market.
The big factor to consider for all mutual funds is costs. Be wary of mutual funds that assess a sales charge or front-end load. Mutual funds are actively managed. It’s important to know 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
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 shares of stock.
ETFs can include any collection of securities, but they typically track popular segments of the stock market and benchmark indices like the Dow and S&P 500. They’re known as index funds, which offer exposure to a portion of the stock market at a fraction of the cost of mutual funds. Since they’re not actively managed, the fees are comparatively minuscule. Other popular index ETFs track indices for various parts of the U.S. and foreign stock markets and the domestic and foreign bond markets, as well.
Benefits and Drawbacks of ETFs
It used to be that brokerage firms charged a commission to trade ETFs. Today, brokers like Charles Schwab, Fidelity, and TD Ameritrade offer a menu of no-transaction-fee ETFs. Free brokerage firms like Firstrade and M1 Finance never charge a trade commission.
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; affordable diversity compared to mutual funds
- Cons of investing in ETFs: Many new ETFs are 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. You can also look into real estate crowdfunding investments through platforms like Fundrise and CrowdStreet, as well as p2p lending investment opportunities through sites like LendingClub.
Traditionally, investments like real estate and lending have been available only 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. It’s called an investment vehicle, and it’s where you’ll stash your securities to make sure they get all the tax benefits that go along with them.
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 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.
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. For tax year 2020, the cutoff is $139,000.
Good To Know
Workplace retirement plans, like the familiar a 401k or the government’s Thrift Savings Plan, are called “defined contribution plans.” For all of these plans, workers 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.
Andrew Lisa contributed to the reporting for this article.