Go long! Or maybe short?
The reality is, not every investment strategy is well-suited to every investor. In fact, based on your risk tolerance and preferred investment style, some strategies may be entirely the wrong fit for you. And one of the most basic differences between strategies is the difference between long-term and short-term investing.
Not sure what the difference is? Here’s a look at long-term and short-term investing to get you started.
What is Short-Term Investing?
Short-term investing deals exclusively with short-term investments, which are assets or securities that can easily be converted into cash within a five-year period, though most are only held for about three to twelve months.
Short-term investments include things like:
- Government bonds
- Money market accounts
- High-yield savings accounts
- Treasury bills
All of these investments are high-quality and high-liquidity. As a result, short-term investing is characterized by rapid turnaround and high liquidity, and while the returns are lower, investors have the ability to withdraw money quickly. And because the investments have a short shelf life, they’re lower risk than long-term investments.
What is Long-Term Investing?
Long-term investing, on the other hand, is built on long-term investments. These are investments that won’t be sold for years, sometimes even decades, and in some cases may not ever be sold. In other words, your money stays tied up in a given investment vehicle for a long period of time.
This is a classic high risk high reward scenario. On one hand, holding your money in an investment for a longer period of time gives the investment more time to accrue value, which means greater returns. On the other hand, it also means that you can’t liquidate the investment easily—and the investment may never deliver returns, which means you kept your money in one place for nothing.
Many investors build long-term investments into portfolios with a specialized strategy. Chances are, you do it too. If you have a 401(k), an IRA, a college savings plan, or a long-term savings account, you engage in long-term investing. As you can guess, most investors rely on long-term investing to build a retirement nest egg.
Long-Term vs. Short-Term Investment
The gap between long-term and short-term investing comes down to three critical differences:
- Time horizon
- Market risk
- Investing goals
Again, short-term investments are usually held for a year or less, while long-term investments are held for at least a year, but often for years on end. This also means that short-term investments are less risky than long-term investments due to increased liquidity, though short-term investments don’t deliver gains as well as long-term investments.
Choosing the right one for you depends on your investing goals.
Long-term investing goals take shape over decades—things like saving for retirement or building your child’s college fund. Short-term investing goals, on the other hand, take shape over a few months or a few years at most. Things like saving up for a home improvement project or even saving up for a wedding are both good examples of short-term investment goals.
Capital Gains and Taxes
Because the investments are structured quite differently, long-term and short-term investing also faces different capital gains regulations and taxes.
In basic terms, capital gains are taxed depending on how long you held them before you sold them. Capital gains for short-term investments are taxed based on your regular income, while capital gains for long-term investments are taxed according to graduating thresholds of taxable income: 0%, 15%, or 20%. Most investors report a 15% tax on long-term investment capital gains.
Are Long-Term or Short-Term Investments Better?
So, are short-term or long-term investments better for your investment strategy? The truth is, it depends on what you’re trying to achieve, and most investors rely on a mix of both short-term and long-term investments.
If you’re not sure which is the right fit based on your goals, here’s a quick breakdown.
When to Choose Long-Term Investments
Long-term investments are held for a long time to help accrue value, which means they’re best-suited to investment goals that will unfold many years into the future.
Retirement is the classic example of this—especially if your retirement is 20 years away or even further. However, long-term investing is also the right choice for plans that will unfold seven to ten years into the future. And since long-term investments have a lot of time to build value, they’re also useful to create a value store against inflation.
When to Choose Short-Term Investments
Short-term investments, on the other hand, are not meant to build a portfolio.
Basically, if you know you’ll need the money soon (as in: within the next five years) you need short-term investments. Otherwise, you’re taking too much risk that the money you need won’t be available by the time you need it.
Short-term investing is also a good choice if you know you’ll rely on investments as a stable source of income. A good example of this is retirees using bonds or annuities as an initial investment that will provide stable income over the course of several years.
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Ultimately, the difference between long-term vs short-term investing comes down to what you want to achieve. Once you understand what you’re looking for, it’s easier to find investments that suit your needs.
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I'm an investment expert with extensive knowledge and experience in the field. Over the years, I've gained firsthand expertise in various investment strategies, risk management, and market dynamics. My goal is to provide valuable insights and guide investors in making informed decisions.
Now, let's delve into the concepts discussed in the article about long-term and short-term investing. The article outlines key differences between these two investment strategies, considering factors such as time horizon, market risk, and investment goals.
Short-Term Investing: Short-term investing focuses on assets or securities that can be easily converted into cash within a five-year period, with most held for three to twelve months. Examples of short-term investments include government bonds, money market accounts, high-yield savings accounts, and treasury bills. These investments are characterized by high liquidity, rapid turnaround, and lower risk compared to long-term investments.
Long-Term Investing: Long-term investing involves holding investments for years, sometimes decades, with the potential for high risk and high reward. Common long-term investment vehicles include 401(k)s, IRAs, college savings plans, and long-term savings accounts. The strategy allows investments more time to accrue value, leading to potentially greater returns. However, it also means lower liquidity and the possibility of not realizing returns if the investment doesn't perform well.
Differences Between Long-Term and Short-Term Investment:
- Time Horizon: Short-term investments are typically held for a year or less, while long-term investments are held for several years or even decades.
- Market Risk: Long-term investments are generally riskier due to lower liquidity, but they offer the potential for higher returns. Short-term investments are less risky with increased liquidity.
- Investing Goals: Long-term goals involve decades-long plans like saving for retirement, while short-term goals encompass a few months or years, such as saving for a home improvement project.
Capital Gains and Taxes: Long-term and short-term investments face different capital gains regulations and taxes. Capital gains for short-term investments are taxed based on regular income, while long-term investments are taxed at graduated thresholds of taxable income (0%, 15%, or 20%).
Choosing Between Long-Term and Short-Term Investments: The choice depends on your investing goals. Long-term investments are suitable for goals unfolding over many years, like retirement. Short-term investments are ideal if you need the money within the next five years or if you rely on investments for stable income.
Ultimately, successful investing involves a mix of both long-term and short-term strategies tailored to individual financial goals and risk tolerance. Understanding these concepts empowers investors to make smart decisions and optimize their investment portfolios.