One of the most successful techniques in wealth creation is to invest for the long term. Investors who hold an investment for the long-term are less likely to suffer from market losses than their shot term speculative cousins. Investors who hold for the long term are less vulnerable to investment timing decisions and more likely to benefit from the overall growth in an economy than their short term peers.
There are several basic principles to which all long term investors should adhere.
For wealth creation dividends should be reinvested. This established a compounding effect which increases the size of the account regardless of the behaviour of the market. The longer the investment is held the greater the effect. For this reason it is advisable to start saving for the long term at the earliest possible age.
Another trick to accumulate capital regardless of market fluctuations is to make regular monthly savings. Regular monthly savings also benefit from an affect known as dollar cost averaging. When stock or bond market prices are low more stock or bonds can be bought than when prices are high. Consequently the investor is protected from market timing issues in which lump sum investments are bought at a high price. This type of investment has a further advantage because the regular savings can be modest sums of just $25 or $50 per month.
Long-term investors typically think in terms of a five, ten or twenty five year horizon. In many cases the long term investment is directed towards building up a retirement income but it could equally well be directed towards building up a lump sum for a key lifetime event such as university education fees for children.
Like all investors long term investors need to consider their asset mix. Prudent investors spread their risk across a range of asset classes. Investments in property, bonds and stock and shares are possible. Although property investment produces good returns over the long term this type of investment is very illiquid: capital is tied up in a single asset for a long time. Bond and stock investments are a better conduit while regular savings accumulate.
Many long-term investors favour bonds which, held to maturity, offer a low risk investment. When choosing a bond, consider choosing one with a high yield. This will maximise the compounding effect over the duration of the investment. When choosing stocks and shares for the long term seek out companies with good long term growth prospects – for the long term investor this is far more important than investing in share tips that will give short term speculative gain.
Prudent long-term investors must decide whether to invest in individual stock and individual bonds or in mutual funds. Investments in mutual funds have the advantage of diversifying the risk across a portfolio. They give the added benefit of in house research and professional stock selection. Research is required to ensure that the shares are chosen for their growth potential. Investors should follow a strategy known as value investing. Companies should be selected that are cash generative in the long-term.
Research involves looking at the company finances and taking a view on their long-term business prospects. When investing in for the long-term investors with a higher than average risk threshold might consider investing in start-up or research companies. This is best accomplished by investing in a portfolio of companies within a mutual fund. Although some high growth companies might fail the success of others will lead to a strong overall performance by the mutual fund.
Investment for the long-term is a well established technique for building financial wealth. It reduced the risk of market timing errors and allows the investor to benefit from capital accumulation through compound interest. Once investments have been made it is important to leave them alone for the duration of the long term investment plan.