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There is no such thing as a get-rich-quick scheme in the financial markets. Instead, there are different types of investments you can use to achieve different goals.
These investments can be categorized into two different types: short-term investing and long-term investing.
Every smart investor understands the difference between the two. They’re both important topics to be aware of to properly allocate your money so you can achieve your financial goals.
By the end of this article, you’ll have a clear understanding of the differences between short-term and long-term investing, and you’ll be able to apply this concept to your investments.
Introduction to Short-Term vs Long-Term Investing
Everyone has different financial goals that can range from a few months up to a few decades.
Some financial goals like buying a car or the down payment for a home may occur within a year. Other goals like retirement may not occur until a couple of decades into the future.
Luckily, there are different types of investments with different time horizons we can utilize to achieve our financial goals.
Let’s start by looking at long-term investing.
Long-term Investing
When referring to long-term investing, this usually means holding your investments for 10 years or more.
People use long-term investments to achieve far-away financial goals such as building their children’s funds for college, saving for retirement, or saving to buy a house.
Long-term investing can also be used to protect your money from inflation. Historically, the average inflation rate has been 3.8% per year, which means every year you lose 3.8% of purchasing power. Investing your money into long-term investments will allow your money to outpace inflation.
Long-term investing strives to achieve capital growth but requires you to stomach the volatile ups and downs of the financial markets. In other words, in order to achieve higher growth, you’re going to need to tolerate higher risk.
Types of Long-term Investments
Stocks, bonds, and long-term certificates of deposits (CDs) are some of the main types of long-term investments.
Stocks yield the highest among the three but also are the most volatile. For example, the financial crisis of 2008 caused the S&P 500 to lose 57% of its value in two years. When investing in stocks, it’s important to remember that volatility is part of the game. It’s the price you have to pay for higher gains. The main thing is to create a plan and stick to it whether the market rallies or drops.
One of the best investment strategies for the stock market is the 3-fund portfolio. It’s a strategy that only involves three index funds and has historically beaten more than 90% of actively-managed mutual funds.
On the other hand, long-term CDs yield lower returns but are much more stable compared to stocks. They provide monthly dividend payouts which are stable and reliable. The downside is that CDs yield less than half of the returns of stocks.
Long-term Investing Risks
When it comes to investing, risk is something you can manage but can’t avoid. Before you start investing for the long term, it’s important you understand the risks associated with it so you don’t panic.
The first type of risk you need to be aware of is market fluctuation.
The financial markets are influenced by multiple economic factors. Therefore, things can get volatile when sudden changes occur to the economy. Take the Corona Virus as an example. It was a pandemic that no one could’ve predicted and caused the stock market to drop 35% within a month.
As I mentioned earlier, volatility is a part of the game. To achieve higher returns, you need to learn how to trust the process and stomach the drops.
The second type of risk associated with long-term investing is illiquidity.
In the finance world, when an investment is “liquid,” it means that it’s easily convertible to cash without affecting its value.
Investments like long-term CDs cannot be converted to cash without giving up a significant amount of returns, therefore they are “illiquid.” Stocks can be easily converted to cash, but doing so during a market downturn would mean selling for a loss. Therefore stocks can be considered illiquid in such aspects.
Should you invest for the long term?
Ask yourself how long until you need the money. If you won’t need it for more than 10 years, this may be for you.
Long-term investing should be for long-term goals. Examples of these goals can include saving for a house, building the funds for your children’s education, and saving for retirement.
You also need to make sure you’re using the correct account. For example, you can use a 401k, or a Roth IRA account to save for retirement and use a 529 account when investing for your child’s education.
Short-term Investing
Short-term investing usually involves holding your investments for less than 10 years.
In contrast to long-term investing, short-term investments are often used for capital preservation. This means that your investments have a lesser chance of decreasing in value while simultaneously receiving a small amount of interest or dividend. Short-term investments are often less risky but yield less returns.
Therefore, people often use short-term investing to serve immediate financial requirements, such as an emergency fund or saving up for a vacation. These need to be liquid and readily accessible in case of an emergency.
Types of Short-term Investments
There are many short-term investment options, but some that stand out are money market accounts, short-term CDs, and savings accounts.
CDs are good for financial goals that have a specific ending date. Let’s say you’re saving for a vacation for one year in the future. A CD for a one-year term would be the perfect option for this. Not only would a CD yield higher than a savings account, but you’d be able to access your money just in time for your vacation.
Money market accounts and savings accounts are great for storing emergency funds. You never know when you may need to withdraw money from an emergency fund, so CDs aren’t the best option.
The main difference between money market accounts and saving accounts is the accessibility of the money and the fee structures. Money market accounts allow you to easily access your money and often come with checkbooks and debit cards. However, most banks do require a higher minimum balance to receive the full dividend yield.
On the other hand, savings accounts have fewer balance requirements but usually don’t come with checkbooks or debit cards.
Short-term Investing Risks
Short-term investments are less risky than investing for the long term. However, the main risk associated with short-term investing is inflation.
As I mentioned earlier, inflation has historically been around 3.8% annually. However, short-term investments would typically yield less than that.
For example, the 10-year treasury rates from the past couple of decades has been around 2-3%. Vanguard’s Total Bond Market ETF have historically yielded around 2.6%, and the interest rate of an average savings account has been around 0.21%.
All three short-term investments have lagged inflation!
Should you invest for the short term?
Short-term investing should be reserved for financial goals that will/might occur in the immediate future.
Examples can include saving for a vacation or stashing money away for an emergency fund. Both of these goals require your funds to be liquid and to not lose value from market fluctuations.
Conclusion
To sum things up, here’s a quick look at the differences between short-term and long-term investing.
| Short-Term Investing | Long-Term Investing |
| Goal of preserving market value while earning a small interest | Goal of growing capital |
| Saving for a vacation, emergency fund | Saving for retirement, children’s college, buying a house |
| Risk of lagging inflation and losing purchaisng power | Risk of market fluctuations |
| < 10 years | > 10 years |
| Savings account, short-term bonds and CDs, money market accounts | Stock market, bonds, long-term CDs |
What are your short-term and long-term financial goals? Let me know in the comments below!
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