Long Term Investments Definition
Long Term Investments refer to the financial instruments in the form of Stocks, Bonds, Cash or Real Estate Assets which the company intends to hold more than 365 days probably to maximize the profits of the company and is reported on the asset side of the balance sheet under the head non-current assets.
- The objective of the company is not to sell the investments held in a short period but to use it as a cushion for future needs.
- It also reflects the risk-taking ability of the company and the comfort to park the excess funds in long term assets that can generate higher returns.
- It generates a steady amount of regular income for the company in the form of interest or dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more that can be used in routine operations.
- They are different from short term investmentsShort Term InvestmentsShort term investments are those financial instruments which can be easily converted into cash in the next three to twelve months and are classified as current assets on the balance sheet. Most companies opt for such investments and park excess cash due to liquidity and solvency reasons.read more where the tenure is less than a year, and the risk is even more.
- A high amount of long term investments also suggest that the person has a high amount of capital to be locked in and is financially very much sound.
- The idea is not to trade the security but to buy the same and hold it till its value increases.
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Source: Long Term Investments (wallstreetmojo.com)
Types
Broadly can be divided into the below-mentioned types :
- Stocks: Investments made in the form of equity shares of the company, which is fundamentally strong and can generate a higher amount of capital appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.read more.
- Bonds: It refers to the investments in the fixed incomeFixed IncomeFixed Income refers to those investments that pay fixed interests and dividends to the investors until maturity. Government and corporate bonds are examples of fixed income investments.read more market in the form of g-sec or debentures, which generates a steady amount of interest income for the company.
- Insurance: Life insurance is also one of the types of long term investment since it insures the entire life of the individual by paying a small amount of premium yearly.
- Mutual Funds: Generally used as a vehicle to park the surplus money in the company to earn a higher rate of interest than fixed deposits.
- Tax-Free Bonds: Generally, investments plan are made here to save tax and earn interest as well.
- Real Estate Assets: Investments made in the real estate assets in the form of land, buildings, etc. are generally locked up for a considerable amount of time until the project is complete.
Examples
- Example 1: ABC ltd being a telecom service provider, needs to invest heavily in technology to run its operations smoothly. The company needs to build a fiber-optic network to build a connection to the people. Such types of investments are referred to as long term investments.
- Example 2: An investment made by a company in 10-year G-sec bonds can be termed as long term investments as the company will keep enjoying the interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more without the fear of losing the entire capital.
- Example 3: An investment made by a real estates fund like Everstone or Blackstone buy investing in a company that builds malls, and commercial towers are termed as a long term investment since it would require at least 5-7 years to execute it.
- Example 4: The investment made by a builder in a real estate project by raising funds from financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more.
Advantages
- Less risk and higher returns: It will always higher returns to the investor who will be invested for a long time, thereby reducing the risk.
- Power of compounding: An investment held for a longer period will generate higher returns since the compounding of the interest factor plays a vital role.
- Discipline: It enables discipline in the investor.
- Wealth creation: It also helps in creating wealth since investing systematically for a longer tenure will give superior returns to the investors.
- Builds confidence: It builds a sense of confidence among the investors and acts as a cushion when the investment starts performing and generating superior returns to its investors.
Disadvantages
- Capital is locked: Investing long term results in locking the funds for a more extended period, which might be even difficult to liquidate in time of need.
- Patience: It requires a high level of patience in the investor to hold on his investment despite any fall in the value.
- Decision making: Sometimes, it would require a significant amount of homework to be done to select the best investment for the company as one wrong thing can ruin the entire story.
- Monitoring: Constant monitoring is required to check the health of the investment, whether its deteriorating or not and take appropriate measures to manage the same.
- Higher risk: Since it is a capexCapexCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more to be made, a lot of risks are involved in the same as entire capital would be blocked for a specified period, which cannot be liquidated easily. Hence the risk of not getting the funds back on time is a concern that needs to be looked into.
- Not meant for speculators: This type of investment is not made for the speculators or the traders who like to earn money daily by buying and selling securities and desirous to be richer in a shorter duration.
Conclusion
Long term investments are one of the types of investingThe Types Of InvestingStocks, bonds, and cash equivalents are the three main forms of investments. Investment, in general, refers to the purchase of anything for future use with the goal of generating a regular cash flow or increasing the value of something over time so that it can be sold for a higher price than it was purchased for, i.e. capital gains. read more in which the funds are locked in for more than a year, and the intent is to carry the same in the books for a more significant period without the intention of selling it. All investors should allocate a certain percentage of their income in long term assets, which will help them to earn higher returns in the long term. Finally, long term investments will always generate more returns than short term investments due to the power of compoundingCompoundingCompounding is a method of investing in which the income generated by an investment is reinvested, and the new principal amount is increased by the amount of income reinvested. Depending on the time period of deposit, interest is added to the principal amount.read more
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