The Importance of a Long-Term Perspective

Investing, according to the dictionary, is a carefully considered, long-term undertaking entered with the expectation of some future benefit.

Setting Investment Goals

Determining your financial goals is the first step to successful investing. This is a crucial step, for many of the decisions you make later will depend on the goals you set now. Establishing investment goals will help you assess how much money you'll need, when you'll need it, and how much you'll need to invest to reach your goal.

Deciding what you hope to achieve will also help you select appropriate investments to meet those goals. Here are some typical investment goals and types of investments often used to meet them.

To meet long-term goals, such as saving for your children's education or your own retirement, growth investments, such as stocks and stock mutual funds, might be suitable choices. Growth investments focus on increasing in value over long periods but can be expected to move sharply higher or lower over shorter periods. Long-term goals allow you to accept more risk than you might otherwise, because the market's ups and downs have tended to smooth out over time.

To meet medium-term goals, such as saving for a house, car, wedding, or dream vacation, many investors turn to bonds or bond mutual funds. Although there have been exceptions, historically bonds have tended to be less volatile than stocks.

To meet shorter-term goals, such as creating reserves for emergencies, investments that seek to protect against loss while still earning a modest income might be suitable choices. Examples of these include certificates of deposit (CDs), money market accounts, and money market mutual funds.

To meet ongoing goals, such as supplementing your income with a steady flow of investment earnings, suitable choices might include bonds, preferred stocks, and bond mutual funds. If you're looking to meet income goals, a tax-advantaged investment may or may not be a better choice for you, depending on your tax bracket. These include municipal bonds, municipal bond mutual funds, and tax-exempt money market mutual funds.

Once you've identified your goals, the next step is to develop an investment plan to meet those goals. Most investors find their plan needs to include different types of investments to help them meet multiple financial goals.

The Benefits of "Buy and Hold"

In volatile market environments, it's important to stick to your well-considered investment plan. There are substantial long-term benefits in buying and holding a diversified investment portfolio instead of trading stocks or mutual funds frequently. In fact, frequent trading can reduce your returns for many reasons:

First, you will be charged transaction fees each time you buy and sell.
Second, the more you trade in an account, the sooner you'll pay taxes on your gains and the higher your tax bill may be.
Third, it's nearly impossible to time the market. You don't want to jump into a "hot" investment just in time to see it cool off.

Researchers have concluded that active trading is actually "hazardous to your wealth." One study compared active traders with investors who generally follow a buy-and-hold strategy. The infrequent traders made few or no changes to their portfolios between 1991 and 1997. The active traders changed their entire portfolio every year. About 20 percent of the investors in the study were active traders.

As the graph illustrates, the active traders paid a high price: their annual returns during the period averaged only 11.4 percent, compared to 18.5 percent returns earned by the infrequent traders. In other words, those who basically bought and held earned more than half again as much as the heavy traders.

The Keys to a Long-Term Investment Perspective

To help maintain your long-term investment perspective and keep your long-term plan on track, follow these simple rules:

Keep your focus and maintain your overall investment allocation.
Select your investments on the basis of long-term merit. Resist making impulsive changes.
Keep short-term market developments in perspective; expect setbacks from time to time. Don't buy and sell new investments unless they are part of your plan. Keep your eye on that long-term goal.

Remember, you invest to make money to achieve a specific goal - not to beat the market. Successful investing isn't a competitive 100-yard dash. Successful investing is more like a marathon, where commitment and endurance will see you to the finish line.