Are You a Short-Term or a Long-Term Investor? Here’s How to Do Both
With investing, time is on your side. The longer you stay in the market, the more opportunities you have to take advantage of compounding.
But every investment carries its own window, and every investor approaches their goals with a certain timeframe in mind. Here’s the catch: you have to approach short-term vs long-term investments differently, and both have critical advantages for growing your money.
Not sure whether you’re a short-term or long-term investor? Here’s a hint: you should be both. Here’s a look at the differences between the two and how you can incorporate them into your investment strategy.
What are Short-Term Investments?
Short-term investments are investments that can be easily converted to cash, typically within five years. However, most short-term investments are liquidated within three to twelve months. They’re also known as marketable securities or temporary investments.
There are two requirements to classify an investment as short-term. First, the investment must be liquid. A stock that trades frequently on a major exchange is an excellent example. Second, the buyer (an individual or a company) must intend to sell the investment within a relatively short period. For investments, that typically means a year or less, no more than five years at most.
There are several types of short-term investments, including:
- High-yield savings accounts
- Cash management accounts
- Money market accounts
- Money market mutual funds
- Short-term government bond funds
- Short-term corporate bond funds
Because of their short shelf-life, short-term investments tend to be lower risk than long-term investments, but they also offer lower returns.
What are Long-Term Investments?
Long-term investments are assets that an individual or company intends to hold for longer than five years. In some cases, the investment may never be sold at all.
With long-term investments, time is everything. These investments increase in value if you’re patient enough, but those value increases are not recognized until the asset is sold except for income-generating investments that deliver returns before sale, like real estate.
Long-term investments are considered riskier than short-term investments. For one thing, your capital is tied up for a much longer period. For another, your returns aren’t guaranteed, and you risk losing more capital and waiting around for nothing if you make the wrong bet. However, because long-term investments require more capital and take longer to mature, they also deliver higher returns than short-term investments.
Some of the best types of long-term investments include:
- Growth stocks
- Stock funds
- Dividend stocks
- Real estate
- Target-date funds
- Roth IRA
- Certain high-value alternative investments, like blue-chip art
While you hold these investments for a long time, you still have to periodically assess if the asset is performing as you hoped, and you still have to decide whether the asset is worth waiting for. That depends on the asset in question and your unique financial goals.
Short-Term Investment vs. Long-Term Investment
The biggest difference between short-term vs. long-term investing is obvious: time. This is incredibly important in deciding which investment is the right fit for your goals. You’ll need the money at a specific point in time, which means you need to choose an investment based on your timeframe first.
However, there are also major differences between short-term and long-term investments that have implications for your investment decisions. The two major ones are capital gains and tax rates.
Capital Gains and Tax Rates
Capital gains are the increase in a capital asset’s value realized once the asset is sold. This may be considered a form of income, which is where capital gains tax comes in. Capital gains tax is the levy on profit for an investment once that investment is sold.
In plain English, any profits you make are taxable. However, the tax rate varies depending on the investment.
Short-term capital gains result from an asset held for one year or less. Note that this is much lower than the typical bar used to qualify short-term investments. Either way, short-term capital gains do not benefit from any special tax rate and are taxed as ordinary income. Because of this, they’re subject to taxation rates based on whatever tax bracket you fall under.
Long-term capital gains (gains from an asset held for more than a year) are almost always taxed at a lower rate because they’re not treated as ordinary income. Instead, they have their own unique tax bracket and are taxed on graduated thresholds of taxable income at rates of 0%, 15%, or 20%. Most investors report long-term capital gains taxes around 15%.
How to Combine Short-Term and Long-Term Investing
A lot of new investors ask whether short-term or long-term investing is better. Here’s the thing: they both have benefits depending on what you’re trying to achieve. In reality, you should try to practice both short-term and long-term investing.
The easiest way to do this is to choose investments based on your timeframe. Retirement investments are the classic long-term investments, since most investors have decades to grow their retirement assets before drawing on them. For a short-term goal, like saving up for a car or a down payment on a house, you should look at investment options that deliver returns within the available time frame and with a degree of safety.
If you’re ready to step up your investment game, you can combine short-term investing with compounding to improve your long-term investment outcomes. The best way to do this is by growing your money through reliable short-term investments and then reinvesting the dividends into long-term investments. You can also ladder short-term investments to deliver returns through the lifespan of a long-term investment so that you can reinvest the returns.
Investment Options That Support Your Financial Goals
The short-term vs. long-term investment debate isn’t about choosing sides. It’s about knowing your options and finding the right fit based on your financial goals.
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