Updated July 20, 2023
Introduction of Long Term Investments
Long-term investment refers to an investment strategy where individuals or entities aim to achieve substantial value increment over a period of time exceeding 12 months.
Companies typically disclose long-term assets on the asset side of the balance sheet, categorizing them under the heading of non-current assets as below:
Extract of the Balance Sheet
|Long term investments||XXX|
Investors undertake long-term investments with a large amount of faith, trust, and belief that the target investment will perform very well over an extended period of time. Such target investment can be just equity investment in any company, or it can be an investment in the project along with taking the risk of the same. Generally, under the generally accepted accounting standards, it is very prudent that all investments beyond 12 months should come under the category of long term investments.
The following are characteristics of Long term investments:
- Long term investments are undertaken with the aim of gaining price appreciation in the longer duration time
- Such an investment horizon can be of 12 months
- Long term investors are willing to undertake a high amount of risk
- The chances of gain under long term duration are much more as compared to short-term duration
- Long term investments have a direct impact on the ratio analysis of the company.
Examples of Long Term Investments
Mr. Peter is having a surplus fund of $ 1 million. He wanted to grow his capital with manifold time. He has options given the below 2 options to invest.
- Liquid mutual fund scheme that gives 6% return in 10-12 months of the horizon
- Stock that gives a 5% return constant based on the trend of the last 5 years
Where Should Mr. Peter Invest?
If Mr. Peter is a risk-taker investor with a good understanding of the market, he will choose Option ii. The reason is Mutual funds are directly dependent on the market scenario. 6% based on the market is for a 10-12 month horizon. There are fair chances that post that market can take a U-turn. However, a Stock that has given 5% growth in the last 5 years is of much more prudent investment option for long term investors. Thus Mr. Peter should invest in the Stock to earn a 5% constant return.
ABC Corp is a tech giant with a presence across the globe. However, they have minimal presence in the area of artificial intelligence, where they are aiming to gain a pioneer position in 3 years of time. The company began deploying resources in the field to identify customers and their requirements and conduct market research on the operation of this technology and potential areas of high future demand.
Considering a long-term vision, we consider such expenditure as a long-term investment.
In the market, various investment instruments are available with different rates of return and different horizon periods. Mr. Thomas has surplus cash of $ 10,000 and has no plan to use it in the foreseeable future. He invested the same in government securities giving 8.5% for the duration of 10 years. This is the simplest example of long term investment in our day-to-day life.
How Long is Long Term in Investment?
Long term is very subjective in nature. Every individual will have different philosophy that is a long duration for them. According to generally accepted accounting principles, long-term investments refer to any type of investments an entity invests for a period exceeding 12 months. However, given below are the broad categories of investment periods for which investors invest with the mindset of long term investments:
With 1 Year Horizon Period
Generally, for mutual funds and deposits, people prefer 1-year investment horizon. The mindset of such investors is that they want to invest for the long term but not more than 1.5 to years. Such investors are both risk-averse and risk-takers.
With 3 Year Horizon Period
3 years is considered as one side of the economic cycle. The effect of short term volatility gets absorbed and a new trend can possibly be seen in the market. 3 years of the period can be accepted as a trend in any market and provides direction towards the further movement of prices.
With 5 Year Horizon Period
Investment in any instrument of any 5 years or above is the prolonged long-term investment duration. Investors with high-risk takers with a strong vision about the specific price trend belong to this category. They will remain firm in their investment decision and will not change it. Generally, Investors in real estate come in this category.
Where to Make Long Term Investments?
Following are the different instruments where investors can make the long term investments:
- Stocks: Investments in the equity of any company are getting covered here. Investors with a strong belief in the management and operations of the company will invest in their stocks for a prolonged period.
- Exchange-Traded Funds: Exchange-traded funds are the pool of investments from large groups of people invested in a variety of stocks based on the expertise of the fund trader. These are very famous presently in the market.
- NPS: Pension schemes are always favorite for the salaried class of people. Post-retirement, they will invest in such schemes and try to get a good pension to secure their future.
- Real Estate: Investment in real estate is always undertaken with a view that prices of specified property will grow in the foreseeable future.
Short Term vs Long Term Investments
|Sr No||Point||Long term investments||Short term investments|
|1||Definition||Long term investments are made with the motive of investing for more than 12 months period||Short term investments are done with the motive of investing for less than 12 months of period|
|2||Example||Investment in Real Estate||Investment in 6 months FD|
|4||Risk matrix||Having high risk as the future is uncertain||Comparatively low risk as trend can be easily predicted for short period of time|
|5||Need for research||Requires very in-depth research||Requires comparatively less research|
|6||Chances of recovery||In the long term, recovery from any fall is possible. Hence there are high chances of recovery.||Short term movements are based on ongoing events. Due to this recovery becomes very tough in short term markets|
|7||Impact of mark to market||Period-end fair valuation of long term instruments affects the balance sheet||Period-end fair valuation of short term instruments affects the income statement|
|8||Current/Non-Current||They are non-current instrument||They are current instruments|
Advantages and Disadvantages
Below are the advantages and disadvantages mentioned:
The following are the advantages:
- Volatility Based on Current Events Can Be Ignored: In the long term, economic movement can be predicted on both sides. Hence, the chances of recovery increase. Hence the impact of present events can be ignored in the long run.
- Exemption From Taxation: Generally, gains from long term investment instruments are exempted in all countries. Due to this, such instruments get tax effective.
- It Is More Cost Effective: The cost of capital can be easily recovered in the long term investment as it will remain the same; however, the rate of return will keep increasing.
- Benefits of Compounding: In the long-term instrument, the Invested amount will get reinvested in the second year, and it will continue. This helps in earning a return on principle and also interest on interest. This gives the compounding effect of earning.
The following are the disadvantages :
- Capital Gets Blocked: Capital gets blocked in the long run for a prolonged duration. This may also result in the opportunity cost of losing a better opportunity.
- Patience: Long term investors must be highly patient with peace of mind. In long duration, they will see many ups and downs, which they must overcome.
- Monitoring: Long term investments are needed to be constantly monitored and need to observe the market that can have a direct impact on the portfolio.
Tips for Long Term Investments
- Keep Portfolio Well Diversified: As all say, never keep all eggs in the same bucket. That saying applies in the field of investment as well. One should always try to invest in a different industry, different sectors, and different investment instruments.
- Retirement Fund: Always invest some of the amounts in retirement funds. This will keep you well protected for your retirement age.
- Manage Your Risks: Always try to balance the risk. Never get exposed to the risk of any specific nature. This may result in disaster. Hence always keep yourself well-balanced in terms of risk.
All investors want to invest with only one aim of earning high returns. One can earn an enormous return if one manages the correct proportion of risk within the correct time. Market rewards to those with the courage to sustain in the market for long. Long term investors fall in this category. Thus, investment in the long term is a good opportunity that requires a good amount of research and alertness.
This is a guide to Long Term Investments. Here we also discuss the introduction to Long Term Investments. How long is the investment, along with some tips, advantages, and disadvantages? You may also have a look at the following articles to learn more –