Long-term investments: when are they the best choice?

News IT @it

9:00 am

3 June 2020

What are long-term investments?

Long-term investments are for investors who look ahead to meet their main objective of increasing capital over time rather than the need to realise immediate returns. In general, they are used for retirement or household savings and enable investors to better diversify risks, as they are held for more than 5 years.

By definition, long-term investments enable investors to risk less in their investment choices because they have clearer objectives and know their own cash needs, which enables them to better design their investment strategy. Long-term investors must be prepared to be patient for a long period of time, but with the knowledge that they will receive potentially higher rewards with lower risks. The costs of investing are also lower than short- or medium-term investment strategies.

The advantages of long-term investments

Planning investments in the long term enables investors to bet on the best financial instruments with the same risk profile, which can, as the case may be, be increased, decreasing the chances of incurring losses. Furthermore, long-term investors have more opportunities to diversify their investment portfolio, calibrating choices according to their objectives and even reinvesting the interest they earn over time.

Longer terms also protect investors from the risk of volatility and from the risk of making rash decisions during market shocks. Buying and waiting to achieve results also means that investors do not need to monitor market performance every day.

Finally, long-term investments enable investors to bet on long-term macroeconomic themes, which are generally sheltered from the fluctuations typical of short-term investments.

The disadvantages of long-term investments

The main disadvantage of long-term investments is the risk of inflation eroding capital. This is difficult to avoid: if inflation rises too much, the initial capital loses value and the actual return on the investment is much smaller.

Investing in the long term means tying up capital for a longer period of time. It follows that investors must first calculate and forecast their cash needs before investing their money with a long-term strategy. In addition, they must resist the temptation to change strategies over time, irrespective of potential fluctuations and changes in markets.

Held to maturity investments

If an entity intends to keep an investment until it has matured and if it can demonstrate its ability to do so, the investment is noted as being “held to maturity”. The investment is recorded at cost, although any premiums or discounts are amortized over the life of the investment.

For example, a classic held to maturity investment was the purchase of PayPal by eBay in 2002. Once PayPal had significantly grown its infrastructure and user base, it was then spun out as its own company in 2015 with a five-year agreement to continue processing payments for eBay. This investment helped PayPal to grow and at the same time it allowed eBay the benefit of owning a world-class payment processing solution for nearly two decades.

Available for Sale and Trading Investments

Investments held with the intention of resale within a year, for the purpose of garnering a short-term profit, are classified as current investments. A trading investment may not be a long-term investment. However, a company may hold an investment with the intention to sell in the future.

These investments are classified as “available for sale” as long as the anticipated sale date is not within the next 12 months. Available for sale long-term investments are recorded at cost when purchased and subsequently adjusted to reflect their fair values at the end of the reporting period. Unrealized holding gains or losses are kept as “other comprehensive income” until the long-term investment has been sold.

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