This is a complete guide to long-term investing in 2022.
If you want to build wealth over a long period of time then you have come to the right place.
We are going to take a deep dive into the fundamentals of long-term investing, what to look for in companies, strategies used by professionals, and how you can get started.
Let’s dive in.
How Investing Works
Before taking the plunge into the investing world, it’s important you understand what it is and why it’s important.
After all, you are putting your hard-earned money on the line.
Check it out.
What is Investing?
Investing is the purchase of an asset with the goal to earn more money in the future. Assets can include anything from stocks and bonds to real estate.
You can invest in almost anything.
This guide is going to focus on stocks and bonds because anybody can start with a very small amount of money.
Why is Investing Important?
Investing can significantly build your wealth over a long period of time.
If you follow a few simple principles, you can end up with a 6-8 figure bank account.
The best part is that it’s all completely passive. There is no additional work that you have to put in, your money works for you.
This graph shows how your money grows over time with a long-term investing strategy.
Your money will grow more and more each year due to compound interest.
Compound interest is what Albert Einstein called the “Eighth wonder of the world.”
Not only do you earn interest on the money you invest, but you also earn interest on interest.
Historically, the average return of the stock market has been about 7% annually. The standard savings account earns .06% annually.
The spread between long-term returns and holding money in a bank is significant.
With higher interest, your returns are exponentially greater than keeping money in a bank or underneath your bed.
This is why investing is important.
Long-Term VS. Short-Term
This guide wouldn’t be complete if we didn’t compare the differences between short-term and long-term investing.
Understanding the differences will help you stay disciplined and make better decisions.
When you invest for the long-term, the time horizon is generally 20+ years down the line.
The time is different for everybody, it depends on when YOU need the money.
Long-term investing tends to produce great returns because companies are resilient and grow over time. Even when there are downturns in the economy, companies almost always recover.
Here is a graph showing the stock market average over a 40 year period from 1980 to 2021.
Do you notice the upward trend? It continues to increase through various economic recessions.
On a few occasions, it would be very tempting to exit the market because it’s going down. But if you keep your money in the market and hold true to your strategy, history shows that you will walk away a winner.
Long-term investors care about the overall trend, not the small ups and downs.
We’ll dive deeper into what a good long-term investment strategy is, but the big idea is to stay in the market as long as possible.
Now it’s time to talk about short-term investing.
Short-term investing is focused on time horizons of one year or less.
The most extreme case is day trading.
Day trading is nothing but speculation, and often times day traders lose money with aspirations of getting rich overnight.
I hate to be the bearer of bad news, but wealth is not built overnight. Building wealth takes time but is very rewarding.
Let’s take a look at the market average over a one day period.
Look at all of the peaks and valleys over the course of a single day.
Short-term traders focus on all the small peaks and valleys and try to guess which way the graph will go.
While there is an opportunity to make money, the fundamentals are non-existent for such a short duration.
Apart from having a very low probability of success, you are putting in much more time compared to long-term investing because you have to constantly analyze and research.
On top of this, you are trading against professionals on Wall Street who can execute trades much quicker than you.
Returns are comprised of two components, capital gains and dividends.
Understanding returns are fundamental to long-term investing because all companies are structured differently.
Some types of companies have high capital gains while others are more dividend focused.
As time goes on and you get closer to needing your money, the types of companies you invest in may change based on their returns.
Capital gains are the appreciation of an asset’s value over time.
If you purchase something for $100 today and it’s worth $150 in one year, that is a capital gain of $50 or a 50% return.
Returns are commonly referenced as a percentage annually because it’s relevant to any portfolio size.
Nobody is going to hold it against you if you refer to a return in dollars, but it’s a little misleading because a $10 gain in a $50 portfolio is vastly different compared to a $10 gain in a $100,000 portfolio.
Dividends are the second part of the equation that are factored into returns.
Companies pay dividends to investors as a reward for owning a share of stock.
Let me show you a model.
After a company receives money, it will first reinvest a portion of it back into the company.
Any money left over will be given to investors in the form of dividends.
Companies typically distribute dividends every 3 months but some pay monthly.
What is a Good Return?
Investors consider any return above the market average to be good.
7% has been the historical market average over the long-term after inflation.
Some years may have returned over 30% while others may have -30%. Even though the market swings daily, it’s the long-term average that truly matters.
Here is a graph showing the annual returns of the market from 1980 to 2020.
Time in the market is more important than timing the market.
Did you ever hear of the snowball effect?
When you roll a snowball downhill it gains momentum and gets bigger.
The same is true for investing. The only difference is that the ball is made of money.
The snowball effect works in investing because of compound interest. You earn interest on your principal investment and interest. That’s right, interest on interest!
Your interest snowballs year after year.
The larger your initial investment and the longer you stay in the market will lead to larger returns.
Types of Investments
Stocks and bonds are the easiest types of investments to understand and simple to get started with.
Understanding the characteristics of stocks and bonds will help you determine an optimal mix for your portfolio.
You can invest in nearly anything from real estate to crypto, but for the purpose of this guide we’ll focus on stocks and bonds.
Stock represents ownership in a company and is measured in shares.
Each share is considered a slice of a company.
Apple for example has 16.53 Billion shares.
Having just one share of Apple would make you a partial owner and give you voting rights into company decisions.
Growth stocks and dividend stocks are the two main types you will see. Each has different growth characteristics.
Growth stocks focus on growing the share price exponentially.
High-growth companies generally don’t pay dividends because they reinvest revenue back into the business to grow even more.
You can see the share price of Microsoft has grown exponentially producing amazing returns.
Growth stocks are the riskiest types of stocks because they are more volatile than others.
Additionally, the only income you will see is when you sell the stock since most don’t pay dividends.
Dividend stocks are favored among many long-term investors because they generate cash flow.
Nothing is more rewarding than seeing dividends show up in your account.
Most dividend oriented companies have linear share price growth and pay dividends on a quarterly basis.
Some companies pay dividends monthly, but most pay every quarter.
Coca-Cola is a great example of a classic dividend stock.
The share price growth is stable and dividends have been increased for 59 consecutive years.
Bonds are similar to loans.
As an investor, you act as the bank where you lend money in exchange for a yearly interest rate for a fixed amount of time.
When the time expires on the bond, the principal is then paid back to the investor.
Bonds are typically issued by the government and local municipalities but there are also private bonds.
Let’s say you lend $1,000 with a 5% annual return for 10 years. Each year you will get $50 and at the end of the 10th year you will receive the principal of $1,000 returned for a total of $1,500.
Each bond is rated based on safety.
Ratings can be anywhere from AAA (best) to D (worst).
AAA bonds have the lowest probability of being defaulted making them essentially risk-free. Oftentimes, the U.S. Government issues AAA bonds and the U.S. Government fully backs all their bonds meaning they must pay back the principal.
Lower rated bonds are referred to as “junk bonds”.
The tradeoff is that the annual return can be much higher but the default probability is much higher as well.
Bonds are seen as less risky than stocks because interest and principal are predictable and more often than not, guaranteed.
Most investors put their money into bonds when they fear the stock market will crash because it’s a safe place to store money.
Risk & Reward
Investing doesn’t come without risk.
There is smart risk and dumb risk.
By maximizing smart risk and minimizing dumb risk, long-term investing will work out in your favor.
Let’s talk about it.
What is Risk?
Risk is the measurement of how large your investments will fluctuate.
The higher amount of risk taken on equates to higher reward potential.
Risk is measured by beta. The market average (S&P 500) has a beta of 1.0.
Any beta below 1.0 is less volatile than the market average.
Any beta above 1.0 is more volatile than the market average.
Taking a standard deviation bell curve and turning it sideways along the Risk & Reward graph will give you a good visualization of how much a holding can fluctuate.
Defensive stocks typically have a beta less than 1.0. Examples include utility and telecommunication companies. The Southern Company (SO) utility has a beta of 0.47.
On the flip side, Tesla (TSLA) has a beta of 1.89. You can see how much the share price has increased in recent years.
You have to decide your risk profile.
Do you want lower returns with more downside protection or higher returns with less downside protection?
Whatever you prefer, you should now have a good basis on what types of companies you want to invest in.
Any risk that can not be planned for is a systematic risk.
Systematic risks include government policies, pandemics, and natural disasters.
These are risks that affect everybody and are ultimately out of your control.
Regardless of what you invest in, you will see systematic risk reflected in your investments.
Unsystematic risk is specific to an individual company or industry.
You can control this risk through diversification.
Let’s say for example that Apple (AAPL) introduces a new social media network to rival Facebook. This is a strategic business decision made by Apple.
If you go all in on Apple and this succeeds, you’ll be rewarded handsomely. If it fails and the share price falls by 50%, so does your portfolio.
To mitigate this risk, investors diversify their portfolios by adding holdings that don’t move alike.
Here are some losers from my portfolio as of now. AT&T and VICI in the telecommunication and real estate industries respectively.
The negative performance is offset by other holdings in different industries that performed well.
Even when Apple performs poorly, you have other holdings to minimize your losses.
This is why so many people encourage diversification in long-term portfolios. Every company has rough periods and investors depend on other holdings to keep everything in control.
You are rewarded from bearing risk, but not unnecessarily.
An unnecessary risk is putting all your eggs in one basket.
What’s the Right Mix?
Now you have to decide what % of your portfolio you want comprising of stocks and bonds.
First, you have to ask yourself when you want the money and how much you need.
Your situation will determine the right mixture of stocks and bonds.
Investors have historically been risk-averse the closer they get to needing the money.
Young people can take on more risk because they have a longer time horizon while older people may consider playing it safer and have a higher weightage of low-risk stocks and bonds.
I hope by now you are starting to see the benefits of long-term investing.
There is no secret formula for picking good holdings to invest in, more people would be millionaires if there was.
While there is no formula, there are a few things you can look for when analyzing a holding to see if it makes sense for you.
I personally use all of these and they have helped me build a healthy long-term portfolio thus far.
Since we are focusing on long-term investing, it’s always a good idea to check how the share price has performed over the history of the company.
Some platforms only show you a history of the past 5 years but that is a relatively short timeframe in the grand scheme of things.
Google is actually a really good resource because you can see the performance over the maximum timeframe.
Simply type the name of the stock you want to look at in Google and click “Max.”
I must emphasize that past performance doesn’t guarantee future results, but it can give you insight into the stability of the performance.
Would you use the product or service yourself?
This is a good question to ask yourself anytime you make an investment.
Don’t just invest because somebody on Reddit or YouTube told you. Think deeply about the quality of the product/service being offered by the company.
If you enjoy using a certain product, odds are many others do as well and the company is doing something right.
Zooming out a bit from looking at the company, it’s also a good idea to observe the industry and where it’s headed.
Look at the energy industry.
Our world is becoming increasingly concerned with renewable energy to help sustain the environment.
The industry is headed in a clear direction and companies who don’t adapt will be left behind.
Another good example is the increased concern for security in the technology industry.
People are very concerned with privacy and we are slowly seeing more companies implement better security policies in their products and services.
I’m a big believer that good leadership produces good results for the company.
Some leaders just naturally have what it takes to make the right decisions and grow the company.
Go to a website like Glassdoor or Indeed and look at the employee reviews.
It’s no surprise that many of the top-rated companies based on employee reviews are top performers in the market. Employees who can get behind the company and leadership will produce better results.
Are You Comfortable?
Lastly, you need to ask yourself if you are comfortable with an investment.
Long-term investors have certain disciplines and know exactly what they want before investing.
Understand Your Objective
- When do you need the money?
- How much do you need?
Determine Risk Tolerance
- What % of stocks and bonds?
- How much diversification?
Ride the Highs and Lows
- Buy during the lows
- Don’t be greedy during the highs
Long-term investing in itself is a strategy. However, I want to dive a bit deeper and look at the primary long-term strategies used.
There is no secret formula or best strategy, it’s whatever works best for you based on your own situation.
These are not mutually exclusive, meaning they can be mixed.
Growth investors primarily invest in high-growth companies in hopes of getting the ultimate return.
They don’t care about dividends because most high-growth companies don’t pay them. This strategy is solely focused on capital gains.
Classic examples are tech companies like Google, Amazon, and Netflix.
Value investing is a strategy centered around purchasing stocks at a discount.
Based on fundamentals, you can determine the true value of a stock. If you find out it’s trading for a value below the “true value” then you should make the purchase.
This takes a lot of skill and there is no definitive method for determining the value of a stock. Analysts do this daily and they still get it wrong most of the time.
A good time to buy is when the market falls due to systematic risk (such as COVID-19). This is known as “buying the dip.”
Investing with this strategy is a bit more time intensive because you have to constantly watch the market.
Dividend-growth investing is purchasing shares of companies that increase their dividend year after year.
Most investors are looking for dividend increases that beat the rate of inflation.
Illinois Tool Works (ITW) has had an annual dividend growth rate of 15.07% over the past 5 years.
Inflation typically sits around 3% giving investors a 12% margin on the dividend increases.
Dividend-growth companies tend to be high-growth and have a lot of cash on hand.
Pure dividend investors focus solely on yield.
Even if the share price is decreasing, yield chasers will invest if the yield is very high.
This can be dangerous because a decreasing share price can pull the total return down even if the company pays dividends.
Prospect Capital (PSEC) pays a high dividend yield but the total return is -44% all time.
This strategy works better when companies grow their share price and pay a fair yield. A fair yield is anything above the market average which fluctuates between 1 and 3%.
You should always be cautious of high-yield companies because it means the company isn’t investing much back into itself to grow.
It has never been easier to get started investing.
There are many great investing applications that offer commission-free trading.
Simply download one of the apps, enter basic information, fund your account, and begin investing.
I am going to focus on M1 Finance because I believe it is the best for long-term investors.
If you want to learn about other apps you can check out my article about the best investing apps.
Investors can purchase fractional shares which are great for stocks that have high share prices.
Maybe you want to invest in Amazon but you don’t want to pay $3,000 for a share. With as little as $1, you can invest in any stock.
Fractional shares offer more flexibility to invest in holdings that have high share prices.
Automatic Dividend Reinvestment
Once your dividends accumulate to $25 or more, you have the option for them to be invested automatically.
This is known as “Dividend Reinvestment Plan” or DRIP for short. Rather than taking dividends out, you can reinvest them into your portfolio to make it snowball quicker.
M1 Finance will invest in holdings based on the weight that you set.
Based on how holdings perform, they can become underweight or overweight relative to what you had allocated.
If you want your portfolio to hold 5% of Apple and the stock performs well, it will become overweight to a number greater than 5%.
If these holdings drift too far from your allocated weight, you can rebalance them back with the click of a button.
M1 Finance allows you to organize your holdings in a way that makes sense to you.
Think of your overall portfolio as a pie, and each holding as a slice.
I have organized my holdings by different industries.
Here is a look at my industrial slice. Within it are my industrial related holdings. I can invest money directly into the entire slice or a specific holding.
Keeping your portfolio organized makes it easier to invest for the long-term because you have full control over everything.
One Trading Window
Some may see this as a negative but I think it’s beneficial.
M1 Finance has only one trading window every day.
This is great for long-term investors because it creates discipline and doesn’t allow for the bad habit of day trading.
The trading window is shortly after the market opens each morning so just make sure you know what you want to invest in prior to its opening.
How to Get Started
To get started, head on over to M1 Finance and apply for your account.
You will need to enter general information as well as your social security and provide identification.
Don’t worry, this information is required by the Securities & Exchange Commission (SEC) and is completely safe.
Once approved, link up your bank account, select and organize your holdings, and make your first deposit.
What all successful investors have in common is that they all focus on the long-term and use simple strategies.
They don’t day trade, and they don’t let their emotions get the best of them.
I would like to introduce you to Warren Buffett, Peter Lynch, and Benjamin Graham. These are the most successful and influential investors of all time.
If you follow in their footsteps I can guarantee you will build enormous wealth.
Warren Buffett is arguably the most successful value investor of all time.
His investing principles are simple:
- Invests only in what he understands
- The business has long-term growth potential
- Leadership is trustworthy and competent
- Company is a good value
Warren is the CEO of Berkshire Hathaway and has amassed a fortune of over $100 Billion.
Berkshire Hathaway yields an average return of 20% which is far above the market. The Warren Buffett method of investing is not complicated and seems to work consistently.
Peter Lynch is a very successful investor who uses very simple methods.
- Buy what you understand
- Do your research
- Invest for the long-term
Peter’s net worth is over $450 million. He managed the Fidelity Magellen Fund from 1977 to 1990 and generated an average return of 29.2%.
Go to Amazon or your local book store and buy The Intelligent Investor by Benjamin Graham.
This is considered the best book on investing and it was the catalyst for Warren Buffett.
Graham explains all the principles of value investing and how to build enormous wealth through long-term investing.
The book dives deep into analyzing a company, the concept of risk, and value investing. Many people have built fortunes based on the principles described in this book.