Knowing when to use long-term and short-term investments to help you achieve your goals is an important part of growing your money. Learn about the advantages and disadvantages of long-term and short-term investment, and which choice is best for your financial future.
When Do You Choose Long-Term Investing Over Short-Term Investing?
Long-term investments are those that you expect to hold for a long period of time.
Long-term investments, according to Wendy Liebowitz, vice president of Fidelity Investments' Fort Lauderdale division, are assets such as stocks and real estate that you intend to hold for a long time. They allow you to develop your portfolio because you know you won't need the money for a long time.
There are a few occasions when long-term investments are preferable to short-term ones.
It'll be more than 20 years before you retire.
If you're more than two decades away from retirement, there's still a long way to go before you quit working. Long-term investments, such as bonds, are a good asset class to create wealth over decades because they need time to develop.
“You have more space to make mistakes and time to rebound from market downturns while you're younger,” Liebowitz said. “Investing in stocks will help you accumulate money for the future. You can adjust your asset mix when you get closer to retirement to include different assets.”
You'll need a plan for the next seven to ten years.
According to David Stein, a former fund manager and author of "Money for the Rest of Us," another factor to remember is the timeline. Low- and medium-risk portfolios are popular in financial strategies for the next seven years. However, once you get into the seven- to ten-year range, you can start thinking about riskier properties, Stein told The Balance over the phone.
“In general, long-term investments like stocks can be used for capital you don't need for a longer period of time,” Stein said. “It's important that you stick to your schedule.”
Stein proposed that you think about what you would need the money and that dividend stocks are a good option for medium-term goals that can benefit from daily payouts as well as growth potential.
You'd like to be protected from inflation.
Long-term investments can also be preferable if you want to beat inflation or be protected from it. Long-term investments, such as bonds, are often regarded as less stable than other assets, but they provide a higher potential rate of return over time, giving you a better chance of preserving your buying power.
Another long-term plan, according to Stein, is to purchase I-bonds. These are Treasury bonds with a fixed rate of return that often keep up with inflation. These bonds are typically structured to gain interest for 30 years, but you can redeem them sooner. 1
The interest rate on an I-bond is made up of a fixed rate and an inflation rate.
“I-bonds by themselves are probably not enough to fully finance retirement,” Stein said, “but they may be part of a long-term strategy.”
When Do You Choose Short-Term Investments Over Long-Term Investments?
According to Liebowitz, short-term investments are those that you intend to use to achieve financial targets in a shorter time period. Rather than building your portfolio, you may need the funds to provide a steady source of income.
Bonds, cash, and annuities are examples of short-term investments. There are certain circumstances under which short-term investments make sense.
You're well aware that you'll need funds soon.
Short-term investments can make sense when saving for shorter-term goals, such as a down payment on a home. Certain savings accounts, for example, will provide a guaranteed rate of return (albeit a low one in most cases) as well as the ability to withdraw funds anytime you need it.
According to Liebowitz, “in general, these types of assets are considered less risky.” “You can hold money in a money market mutual fund or short-term bonds and hope to be able to access it for a short-term target without fear of a market loss.”
When it comes to liquidity, or the ability to access the money you've invested, market loss is a big factor. When it comes time to withdraw your money, you can lose money if you choose a risky option like stocks.
Though deposit accounts have consistent returns, those returns may not keep up with inflation in some cases.
If you need money quickly but want to earn returns in the meantime, a CD ladder is another choice. Before you deposit your money, however, familiarise yourself with your financial institution's withdrawal policies and penalties. If you wish to close your CD before the end of its term, some banks, for example, can require you to forfeit some of your earned interest.
You're looking for a consistent source of income.
Short-term investments are often linked to a steady income. When you know you'll need consistent profits, investing in high-rated bonds and other assets will help. Although the return isn't as good as it might be with certain stocks, you have a better chance of dependable profits.
Annuities, according to Liebowitz, will fall into this category for certain people. “While not for all, the right contract will provide you with consistent income for short-term requirements.”
Annuities, on the other hand, have their own combination of advantages and disadvantages. They can, for example, include lifetime income, guaranteed growth (for fixed-rate annuities), and tax deferment, but they usually come with high fees, surrender costs, and can result in tax issues.
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