As an investor, you’ll often be advised to put your money into diverse assets to help reduce your risks. One way of categorizing investments involves the length of time you plan to hold a particular asset.
Maybe you’re looking at short-term goals such as financing a vacation or buying a home.
Or maybe your outlook is more focused on the long-term, like funding your retirement or paying for a college fund.
Whatever the case, the strategy you bring to your investment portfolio needs to mirror these goals, in order to both maximize your returns as well as keep your potential losses under control.
The truth is, investing is not a get-rich-quick scheme. It’s a long-term process that requires your patience and calm — this can be challenging during inevitable market corrections and fluctuations that can quickly raise your blood pressure.
If you’ve heard of long-term and short-term investments, but aren’t sure what the differences are, it’s hard to choose the best strategy for your own investments.
Consider the following to get started…
A long-term investment usually offers a chance to maximize returns over 10 years or longer. Stocks and index funds fall under this category.
You purchase shares of company stock in exchange for partial ownership of the company. Stocks are categorized based on company size, type, and potential for growth. An index fund is a mutual fund that tracks against a market index like the Standard & Poor’s 500. It gives you broader market exposure and low portfolio turnover.
In long-term investing, more aggressive strategies are generally considered less risky simply because your horizon is further off. For example, you might invest in an aggressive stock with the likelihood of higher return several years down the road. As a long-term investor you need to be comfortable with that risk given that you are not expecting the upside for some time and can wait for it.
The number-one rule for long-term investing is not to panic and sell every time the market drops. That’s a sure-fire way to lock in your losses.
Remember that the market is cyclical. Given time, most assets with recover from a price drop. Pulling out when prices bottom out typically means you lose part of the money you originally invested.
If you avoid micromanaging your investments, it may prevent you from panic selling every time the market dips.
This is one of the main differences in managing short-term versus long-term assets. For long-term assets, sit tight and wait for prices to recover.
Your risk profile determines how much risk you are willing to bear. The length of time you plan to keep your money tied to the investment is a key factor in making this decision. More aggressive investments, for example, make a great choice for longer-term goals, such as college savings and retirement planning. However, if you need the money to pay off within a few years, a financially conservative approach makes more sense. On the other hand, you wouldn’t get a high return on your investment if you put your money in a long-term investment then sell it in a few years.
Real estate is a great long-term investment, but it comes with its own set of risks, such as price increases that outpace inflation and end up in brutal market corrections. Real estate investment funds offer more diverse holdings over a variety of property types and might be a better investment for risk-averse investors.
A short-term investment is usually held less than 3 years before being sold or converted to cash. While many people invest for a living using on short-term swings, it can be very risky and requires a huge commitment of time and research. That’s why long-term investing is best for most people. It’s largely hands-off and isn’t as risky overall.
However, short-term investing can come with big payoffs for those who know what they’re doing — or hire other people who do.
Consider a money market fund. It provides each investor a secure and highly liquid cash-equivalent asset based on debt. However, with the low risk comes a lower return on investment.
Day traders are a well-known type of short-term investor. Those who buy and sell stocks for a living may see greater returns when they trade single stocks. However, the average return of the stock market remains 7%. If you do go down this path, don’t place all your capital in one or a few companies. Diversity is the key to minimizing risks, so spread your investment over several industries and companies of varying size.
Unless you have the time and inclination to carefully manage your investments, it might make more sense to choose a few well-performing mutual funds that already purchase a variety of stocks.
Also, although you may not go to Las Vegas to set up your investments, remember that stock trading is also a form of gambling — don’t use your mortgage money to fund your future investment empire.
Mutual funds come with risk reduction, advanced portfolio management, dividend reinvestment and low entry barriers that appeal to beginning investors. Disadvantages include tax, high fees and the potential mismanagement of the fund.
Whatever the case, the key to reaching your financial goals starts with defining exactly what you want to accomplish with your money and setting up the right kind of portfolio strategy to help you get there.