Short-Term Investing and Performance

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When you hear an adviser recommend a "short-term" investment or you read a financial news article about being a short-term investor, what does that mean? How long is short-term and how does one go about investing for the short term?

Definition of Short-Term Investing

Short-term, with regard to investing, generally refers to a period of less than three years. This is also generally true for categorizing investors as well as bond securities. In fact, many investment securities, including stocks, mutual funds, and some bonds and bond mutual funds, are not suitable for investment periods less than three years. This is because the majority of investors are of the long-term variety, which is to say they are investing for financial goals, such as retirement, that have time horizons that span several years or even decades.

For example, if an investment adviser asks questions to gauge your risk tolerance, they are seeking to determine what investment types are suitable for you and your investment objectives. Therefore, if you tell the adviser your investment objective is to save for a vacation you are planning to take two years from now, you would be categorized as a short-term investor. Therefore short-term investment types would be ideal for this savings goal.

Bonds and bond funds are categorized as short-term if the respective maturity (or more accurately what is called duration)is between 1 and 3.5 years.

Short-Term Performance In Relation to Investment Analysis and Research

When researching and analyzing investments, especially actively-managed mutual funds, a 1-year period does not provide any reliable insight into a particular fund's prospects for performing well in the future. This is because 1-year periods do not reveal enough information about a fund manager's ability to manage an investment portfolio through a full market cycle, which includes recessionary periods as well as growth and it includes a bull market and bear market.

A full market cycle is usually 3 to 5 years. This is why it is important to analyze performance for the 3-year, 5-year and 10-year returns of a mutual fund. You want to know how the fund did through both the ups and the downs of the market. Therefore, the short-term (less than three years) is not a consideration when researching mutual funds for long-term investing.

Examples of Short-Term Investment Types

If you have an investment or savings objective that has a time horizon of fewer than three years, appropriate investment types include money market funds, Certificates of Deposit (CD), and short-term bonds. Long-term investment vehicles, such as stocks and stock mutual funds, carry too much market risk for short-term investment objectives. For example, if you believe you may need your money within the next three years, investing in stock mutual funds is too risky because a prolonged period of declining prices, also known as a bear market, can cause the investor to end up with less principal than they invested.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.