Knowing when to use long-term and short-term investments is part of growing your wealth in a way that helps you reach your goals. Learn the strengths and weaknesses that long-term and short-term investing offer, and which option may be a better fit for your financial future.
When to Choose Long-Term Over Short-Term Investments
Long-term investments are those that you know you’re likely to keep for a long time.
Wendy Liebowitz, vice president of Fidelity Investments’ Fort Lauderdale branch, told The Balance in a phone interview that long-term investments are generally assets like stocks and real estate that you plan to keep for a while. They provide opportunities for growth in your portfolio because you know you won’t access the money for a significant period of time.
There are a few times when it makes sense to use long-term investments rather than short-term ones.
Your Retirement Is More Than 20 Years Away
If you’re more than two decades out from retirement, you still have a considerable amount of time before you stop working. And, since long-term investments like stocks need time to potentially grow, they’re a decent asset class to build wealth over decades.
“When you’re younger, you have more room to make mistakes, and you have time to recover from market downturns,” Liebowitz said. “Using stocks in your portfolio can help you build that wealth for later. As you get closer to retirement, you can change your allocation to incorporate different assets.”
You Need a Plan for Seven to 10 Years in the Future
Another consideration, according to David Stein, a former fund manager and the author of “Money for the Rest of Us,” is to look at your timeline. Financial plans for the next seven years typically include low- and medium-level risk portfolios. However, once you move into the seven- to 10-year range, you’ll want to consider riskier assets, Stein told The Balance by phone.
“In general, for money you don’t need for a longer period of time, you can use long-term investments like stocks,” Stein said. “Your timeline matters.”
Stein recommended considering when you might need the money and suggested dividend stocks as an acceptable choice for medium-term goals that can benefit from regular payouts, plus growth potential.
You Want Protection From Inflation
Long-term investments can also be better when your goal is to beat inflation or receive protection from inflation. Because long-term investments, like stocks, are often considered less safe than other assets, they provide a higher potential rate of return over time, allowing you a better chance of maintaining your purchasing power.
Another long-term strategy, Stein pointed out, is to buy I-bonds. These are Treasury bonds that have a fixed yield but also keep pace with inflation. In general, these bonds are designed to earn interest for 30 years, although you can turn them in earlier.
An I-bond’s interest rate is a combination of a fixed rate and an inflation rate.
“I-bonds alone probably aren’t enough to completely fund retirement, but they can be part of a long-term strategy,” Stein said.
When to Pick Short-Term Over Long-Term Investments
Short-term investments, on the other hand, are those you plan to use to meet financial goals within a shorter time frame, according to Liebowitz. You might need the money to provide a stable income source, rather than to build your portfolio.
Short-term investments might include assets like bonds, cash, and annuities. There are some scenarios in which it makes sense to consider short-term investments.
You Know You’ll Need the Money Soon
When saving for shorter-term goals, like a down payment on a home, using short-term investments may make sense. Certain deposit accounts, for example, can provide a set rate of return (albeit a modest one, in most cases) and allow you to withdraw money whenever you need to.
“In general, these types of assets are considered less risky,” Liebowitz said. “You can keep money in a money market mutual fund or short-term bonds and reasonably expect to access that money for a shorter-term goal without fear of a market loss.”
Market loss is a key factor when you consider liquidity, which is your ability to access the dollars you invest. If you pick a volatile option like stocks, you may lose money when it’s time to withdraw your cash.
Though deposit accounts offer stable returns, those returns (in some cases) may not outpace the inflation rate.
A CD ladder is another option if you need your money soon but want to earn returns in the meantime. However, know your financial institution’s withdrawal rules and penalties before you deposit your money. Some banks, for example, may require you to forfeit some of your earned interest if you want to close your CD before its term is complete.
You Want a Regular Source of Income
Short-term investments are often associated with a stable income. So, when you know you need regular income, shifting more toward highly-rated bonds and other assets can help. While the return isn’t as high as you’d potentially see with some stocks, you have a greater chance of income you can rely on.
“For some, annuities can fall into this category,” Liebowitz said. “While not for everyone, the right contract can help you with regular income for short-term needs.”
Annuities have their own set of pros and cons, though. For example, they can provide lifetime income, guaranteed growth (for fixed-rate annuities), and tax deferment, but they typically have high fees, surrender charges, and can cause tax issues.
Anytime you’re planning an investment strategy, you need to consider both long-term and short-term goals and choose investments that reflect your objectives. Finding balance is an important part of putting together a portfolio that works for you.
- Long-term investments are those that allow you to grow your portfolio and meet goals several years—or even decades—in the future.
- Short-term investments are designed for goals that are closer at hand and can provide access to returns considered safer.
- You should have a mix of long-term and short-term investments in your portfolio.
Frequently Asked Questions (FAQs)
What are growth stocks?
A growth stock is a share in a company that's expected to grow at a faster-than-average rate. These stocks typically don't pay dividends because the companies are reinvesting their earnings to continue their growth.
What are index funds?
An index fund is a mutual fund or exchange-traded fund (ETF) that tracks a financial index like Standard & Poor's 500 Index (S&P 500), the Nasdaq Composite, and the Dow Jones Industrial Average. Index funds offer some diversity and low operating expenses, so they're a popular choice for IRAs and 401(k)s.