Are Long-Term or Short-Term Investments Better?
Investing isn't a get rich quick tactic or something you can do for a short period of time and expect to make a significant amount of money. It's often a long-term process, one that requires patience, commitment, and keeping calm when the market fluctuates, as it inevitably will.
But there are options for investing on a short-term basis, as well as options for investing to reach a long-term goal. You may have heard of long-term investments and short-term investments, but are unsure of what they mean, what the difference is, or what investment strategy is best for you. First, let's define the terms. A long-term investment is an investment that has a higher probability of maximizing your return over a 10-year period. Examples of long-term investment vehicles include stocks and index funds.
A short-term investment is an investment you expect to hold for 3 years or less, then sell and/or convert to cash. Examples of short-term investments include money market funds, certificates of deposit, and short-term bonds. While many people try to play the market or speculate with "day trading," it is a risky business and you should educate yourself and do your research before you try short-term investments. For most people, it is easier, and safer to plan on long-term investments.
Read more about short- and long-term investments below to determine the best investment vehicle for you.
Long-term investments are investments that pay off over a period of several years. When investing long-term, you are able to be more aggressive, so you could opt to invest in an aggressive mutual fund to get the highest rate of return.
Determine the rate of return you want, then look for a mutual fund that averages that rate of return over a 5 to 10-year period. When you invest for the long-term you should not panic when stocks drop and you should not sell when the market looks bad. Here's why: The market is cyclical and has always recovered from drops in the past, although it may take time to do so. However, if you pull out when prices are low, you may lose a portion of the money you initially invested. If there's a dip in the market, you should sit tight and not pull out your money.
Let them recover over time.
Worth noting: the longer you have to invest your money the bigger the risks you can take. If you need the money in the next few years, you will want to take a more financially conservative approach to your investments and may opt to invest in a more secure type of investment. Another factor in choosing the type of investment may be what you are planning on using the money for. This may determine how much risk you feel comfortable with while investing.
Long-term investments are more suitable for investors looking to save for a long-term goal, such as retirement or a college fund. You should not put money into a long-term investment if you plan to sell in 3 years, or are working toward a more short-term goal, like a vacation.
As the name implies, short-term investments that are sold after 3 years or less. Examples of investment vehicles that lend themselves to a shorter investment period are stocks, mutual funds, and some bonds and bond mutual funds.
You may also hear of short-term investors being referred to as "day traders." Before taking this on, you should understand the basics of the stock market, be careful of single-stock purchases, and be mindful that it's very, very difficult to gain higher returns than the average rate of return of the stock market (about 7%) by trading short-term.
Additionally, you should not have all of your investments in just one company. If that company were to go under then you would lose everything. Spread your stocks over a variety of companies and types of companies. For this reason, it is often easier to choose a few good mutual funds that already spread the risk by purchasing several different types of stock. And only invest money that you are willing and comfortable losing.
Finding the Right Balance
When it comes to investing, it is important to find the right balance for you and your individual situation. Before you start investing, whether it be short or long-term investing, you should have clear goals in mind.
Even if you are most interested in short-term investments, you should set aside a portion of your money for long-term investments. This will protect you if you were to lose your money because of a sudden market crash or bad investment. Investing is an important wealth-building tool and not something to avoid or be afraid of.
- Consider using a financial planner to help you determine your financial goals and risk tolerance. A financial planner can also help you create an investment portfolio that lines up with those factors. Your financial goals will also help you and your financial planner determine the best course of action for your investments since when you need the money can also help you determine the amount of growth you need in a specific time frame.
- A general rule of thumb when investing is to diversify your investments, i.e. buy different types of stocks across different sectors of the markets, and have a good balance of riskier investments versus those that are a less risky.
- If you are investing to reach a specific financial goal, like paying for a child's college education or saving for retirement, your investments should start out riskier, then become more conservative as that date gets closer.
Updated by Rachel Morgan Cautero.