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 dividends that can be used in routine operations.
- They are different from short term investments 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.
Types of Long Term Investments on Balance Sheet
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 appreciation.
- Bonds: It refers to the investments in the fixed income 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 on a yearly basis.
- Mutual Funds: Generally used as a vehicle to park the surplus money in the company in order to earn a higher rate of interest than fixed deposits.
- Tax-Free Bonds: Generally investments plan are been made here in order 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.
Below are some of the examples for long term investments on the Balance Sheet :
- Example 1: ABC ltd being a telecom service provider needs to invest heavily in technology in order to run its operations smoothly. The company needs to build a fiber-optic network in order 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 income without the fear of losing the entire capital.
- Example 3: An investment made by a real estate 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 institutions.
Advantages of Long Term Investments on Balance Sheet
- 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 of time 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 of Long Term Investments
- Capital is locked: Investing long term results in locking the funds for a longer period of time 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 in spite of any fall in the value.
- Decision making: Sometimes it would require a great amount of homework to be done in order 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 capital expenditure to be made, a lot of risks are involved in the same as entire capital would be blocked for a certain period of time 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 on a daily basis by buying and selling securities and desirous to be richer in a shorter duration.
Long term investments are one of the types of investing 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 larger period of time 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 compounding
This has been a guide to what is Long Term Investments and its definition. Here we discuss the various types of long term investments on the balance sheet along with the examples. You can learn more from the following accounting articles –