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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