Setting a timeline and a target amount for your investments matters. This is because the way you approach a short-term investment is very different from a long-term investment strategy, and they often cater to different goals. Your day-trading stock portfolio, for instance, will look very different to the retirement portfolio you plan to use in 30 years’ time. Both strategies have their unique strong suits depending on the investment goal in question, so it is important to understand their differences when planning your investments.
What makes them different?
The distinction between them is straightforward. Short-term investments are investments that can be turned to cash quickly, usually within five years if you’re talking about the investment industry, or within a few days, weeks or months if you’re trading. This largely depends on the underlying asset. For instance, a stock held by a day-trader will be a liquid, short-term investment, but if it was in a stocks & shares ISA it would have a long-term investment objective.
Long-term investors, on the other hand, invest in financial instruments that they plan to hold for a long period of time. Most traders keep these investments for several years – putting them into portfolios for specific goals, such as long-term savings accounts or real estate. Any asset can be invested for the long term. They are often illiquid assets, and their value increases slowly but steadily.
Delving deeper, the two investing styles have key differences in terms of the role they play in a portfolio. Here are a few examples:
Short-term investments have a higher risk profile than long-term investments. While volatility isn’t always a good thing for long-term investments, it helps short-term traders make money.
In the short term, risky investments fluctuate a lot and can earn either substantially higher or substantially lower returns than smaller risk investments. Indeed, a short-term investment in a high-risk asset could result in big losses when it comes time to liquidate the investment.
While your short-term investments shouldn’t be too risky, likewise your long-term investments should not be overly safe. Longer-term investments in low-risk assets can lead to wasted opportunities. For example, just a 2% increase in annual return over 30 years equals a 50% increase in overall wealth. To be able to maintain any investment, you must be comfortable with the risk level you choose. AI (Artificial Intelligence) is often used to reduce risk and volatility in long-term investment portfolios to further enhance the long-term strategy.
Adjusting for your risk tolerance is key – while taking too much risk can be a bad idea, taking too little risk can be just as undesirable. The exception to this rule of course is day traders, who aim for large volatility fluctuations in an asset over a short period of time to gain profit.
It is also important to consider when you intend to use the money you’re investing. A year’s time? Ten years? Fifty years? A liquid investment is one that can be swiftly and easily converted into cash at a minimal cost.
The ease with which you can turn an investment into cash, and thereby afford what you’ve been saving for, is determined by its liquidity. A stock like Apple, for instance, is liquid and can be sold in minutes on the stock market. However, something like property is not so liquid. Selling a property at the desired price can take months and fees can add up, and you may have to wait a lot longer than you anticipated for the property sale to be converted into usable cash.
Passive and active investing
Short-term investments are common among active investors. These are confident traders who move their products often, so their assets by definition are considered short-term investments. The aim of active money management is to outperform the stock market by taking advantage of short-term price fluctuations. It involves a deep level of understanding and analysis of when to enter or exit a certain stock, bond, or other assets.
Passive investors, on the other hand, tend to buy and retain their assets for extended periods of time. This makes their assets long-term investments. Passive investors keep their portfolios simple and minimize their buying and selling, making it a particularly cost-effective approach to invest. A buy-and-hold mindset is essential for this strategy – this implies resisting the urge to respond to or predict the stock market’s next move.
In investing, you have both immediate and horizon goals. Investors typically select investments depending on these personal goals.
Short-term investments cater to immediate objectives. A professional trader, for instance, tends to hold short-term assets if they are living off the earnings generated by their trading. Their goal in this situation will be to earn money within the next few weeks or months. They may wish to buy a new car or contribute to a holiday fund – positions that will likely close within the next year.
Then there are those who have “horizon” goals in mind. These are investors that are putting money aside and trading for the future. If you’re saving for a home or a retirement fund, these are examples of horizon goals. This position will not be closed out in the next year, as the investor will plan to keep this portfolio for a long time. This portfolio will be filled with long-term assets that increase in value over time, like Exchange Traded Funds (ETFs).
When to choose one or the other
It’s important to balance strategy with need. Short-term investing plans are often created for shorter-term goals, such as those that are a few months or years away. Short-term investments normally provide lower rates of return over time than investing in an ETF long-term, but they are highly liquid investments that allow investors to make money rapidly if needed.
Long-term investment strategies are a great way to build wealth and ultimately support major purchases or life events that are years, or even decades into the future. Goals like retirement or university often need large sums of money, so in this case, planning your investment strategy ahead of time is beneficial. Long-term investors are typically ready to endure higher levels of volatility or risk in the hopes that these fluctuations will smooth out over time—as long as the investment has a positive, increasing trajectory, of course.
Both long-term and short-term investments are a way to build wealth and increase the returns of your overall portfolio. It’s not about choosing one or the other. Whether the purpose of your investment is to build wealth or create passive income, a combination of both strategies will be your best bet at fulfilling the different goals you have. For example, short and medium-term investments can now be secured against property – typically considered a ‘long-term’ investment – in the case of using credit loan firms to invest in bridge loans (London is a prime example).
It’s about building a portfolio the right way, through controlling risk and increasing diversification. As an example, if you invest only in a specific sector because you expect its future potential to grow exponentially over the next 15 years, and something goes wrong, then your approach is wrong despite being a ‘long-term’ approach. Likewise, if you invest 100% of your money in long-term real estate without geographical diversification you could lose all your money.
Ultimately, using both short-term and long-term investment instruments is beneficial to investors as it helps to achieve high levels of diversification and control risk.
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