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Understanding the difference between long-term and short-term investments may help investors build their investing strategies. Developing this knowledge can be the first step in identifying the investment securities that are suitable for your goals. Here's what to consider.
What Are Long-Term Investments?
Long-term investments are bought and held for multiple years, such as 10 years or more. This investing strategy may be suitable for long-term financial goals such as retirement, and can include certain stocks and mutual funds.
When an investor has several years or more until they plan to begin making withdrawals from their investment accounts, they might see themselves as being in a position to take on more risk than if they had only a few years to invest. This is because the longer periods of time could allow the investments to potentially recover from periodic declines in value. Of course, such a recovery is not guaranteed; any investment can gain or lose value over time, including the possible loss of the principal investment value.
What Are Short-Term Investments?
Short-term investments are typically bought and held for a shorter period of time — generally three years or less. They are typically suitable for needs or goals that are more immediate or in the near future. If an investor chooses a short-term investing period, they might consider investment types that have relatively low market risk. Seeking lower market risk does not guarantee gains or a sustained principal value, though.
Examples of short-term investments can include certificates of deposit (CDs), money market accounts, government bonds and Treasury bills.
Long-Term vs. Short-Term Investing
Here are some of the differences between long-term investing and short-term investing:
- Time Horizon: The length of time before you begin taking withdrawals from your investment accounts defines your time horizon. Long-term is generally considered to be 10 years or more, while short-term is generally three years or less.
- Market Risk: Market risk is the possibility that assets exposed to the market may lose value. The level of market risk that's associated with an investment depends on the type of investment and your strategy. As you determine whether short- or long-term investments are right for you, consider discussing market risk with a financial professional.
- Investing Goals: Long-term investment goals typically take years or decades to reach and may include retirement and saving for college. Short-term investing goals may take months or a few years. Examples of short-term investing goals can include saving for a vacation, wedding or home improvement.
Planning Long-Term & Short-Term Investing Strategies
Long-term investment strategies can help support major purchases or life events that are several years or even decades away. Since long-term savings goals, such as retirement or college, often require large sums of money, it might help to plan your investment strategy as far in advance as possible.
Short-term investment strategies are typically designed for smaller goals that may be months or a few years away. Because of the shorter time frame, investment types that are appropriate for short-term goals are typically different than investment types used for long-term goals.
Even though they may have different time horizons and different associated tactics, long-term investment strategies and short-term investment strategies can both be formed in part by answering some of the same questions.
Here are some questions to explore before forming investment strategies:
- How much money will you need? To answer this question, you may need to make a few related assumptions. For example, if you're saving for retirement, you'll likely want to consider your life expectancy, desired retirement lifestyle and health care needs, among other factors.
- How will taxes factor into your investment strategy? Like inflation, taxes can have a large impact on your investment strategy. For example, you may want to consider accounts with specific tax features, such as 529 college savings plans, which offer tax-deferred growth of your investment.
- When will withdrawals begin? This is another way of asking how long your investing strategy will be. For example, if you're saving for your child's education, you could assume that withdrawals will begin in their first year of college.
- How long will withdrawals last? You might prefer to not end a long-term investment strategy with one lump sum withdrawal. For example, if you expect to retire at age 65 and assume a life expectancy of 85 years, you might want your withdrawals to last 20 years. However, for short-term goals, such as a vacation, you might withdraw one lump sum.
- Will you invest a lump sum or make recurring investments? When calculating the ultimate amount you can potentially reach by the end of your savings goal, you'll need to assume the frequency of payments or investment purchases. For example, will you invest a lump sum up front? Will you contribute a certain amount at the beginning of each year or will you invest a fixed amount every month?
- Which investment types will you use? The investment types you use may be chosen according to the rate of return you want and your tolerance for risk. The amount of time you have to invest can also help you determine the investment type to choose.
Who Might Consider Long-Term Investment Strategies?
Put simply, long-term investment strategies can be useful for anyone who has a savings goal that is at least several years away. In the world of personal finance, long-term goals are generally considered to be at least seven to 10 years away.
Long-term investment strategies might be considered by investors who want to:
- Save for Retirement: This is a common reason for a long-term investment strategy. This is because, for many, retirement can be the largest financial goal of a lifetime, as well as the longest to reach.
- Save for College: Higher education is expensive and the cost is rising. Long-term investment strategies can be an important means of paying for college.
- Build Wealth: Long-term investment strategies could help grow money over time.
It's important to keep in mind that the typical long-term investment types are not appropriate for all investors. For example, stocks and stock mutual funds can potentially make useful long-term investments. However, the potentially higher relative performance of stock investments comes with greater market risk. Therefore, people with low tolerance for risk might consider other investment types to diversify their holdings with lower-risk investments.
Who Might Consider Short-Term Investment Strategies?
People investing for savings goals that are less than three years away may think about exploring short-term investment strategies.
Short-term investment strategies might be considered by people who are saving for:
- Vacations: You might prefer to plan that big trip you've always wanted by funding it with money you've invested, rather than putting it on a credit card and accruing debt, for example.
- Weddings: You may have anywhere from a few months to a few years to save for all of the expenses related to a wedding. The right short-term saving strategy can help make your big day the best it can be.
- Gifts: Whether it's for birthdays or major holidays, you may choose to keep money in an interest-bearing account for purchasing gifts for friends and family.
- Home Improvement: Rather than take money out of home equity, a short-term investing strategy may help you fund home improvement renovations or projects.
Balancing Strategy With Need
Your time horizon, or the number of years until withdrawals from the investments are expected to begin, is one determining factor in choosing suitable investment types. Just like planning a trip, you want to choose the best vehicle to get you where you want to go.
It's important to note that investors should also consider their risk tolerance when choosing investments. Although stocks and stock mutual funds may be appropriate for long-term investment strategies, these securities may not be suitable for an investor based on other aspects of their consumer profile.
Also, keep in mind that planning for long-term savings goals could be more complex than short-term savings goals. If you're planning for long-term goals, such as retirement, it might be helpful to use a retirement calculator. It may also be helpful to speak with a financial representative who can help form and implement your investment strategy.