Knowing when to use long-term and short-term investments is part of growing your wealth in a way that helps you reach your goals.Learn the strengths and weaknesses that long-term and short-term investing offer, and which option may be a better fit for your financial future.
When to Choose Long-Term Over Short-Term Investments
Long-term investments are those that you know you’re likely to keep for a long time.
Wendy Liebowitz, vice president of Fidelity Investments’ Fort Lauderdale branch, told The Balance in a phone interview that long-term investments are generally assets like stocks and real estate that you plan to keep for a while. They provide opportunities for growth in your portfolio because you know you won’t access the money for a significant period of time.
There are a few times when it makes sense to use long-term investments rather than short-term ones.
Your Retirement Is More Than 20 Years Away
If you’re more than two decades out from retirement, you still have a considerable amount of time before you stop working. And, since long-term investments like stocks need time to potentially grow, they’re a decent asset class to build wealth over decades.
“When you’re younger, you have more room to make mistakes, and you have time to recover from market downturns,” Liebowitz said. “Using stocks in your portfolio can help you build that wealth for later. As you get closer to retirement, you can change your allocation to incorporate different assets.”
You Need a Plan for Seven to Ten Years in the Future
Another consideration, according to David Stein, a former fund manager and the author of “Money for the Rest of Us,” is to look at your timeline. Financial plans for the next seven years typically include low- and medium-level risk portfolios. However, once you move into the seven- to ten-year range, you’ll want to consider riskier assets, Stein told The Balance by phone.
“In general, for money you don’t need for a longer period of time, you can use long-term investments like stocks,” Stein said. “Your timeline matters.”
Stein recommended considering when you might need the money and suggested dividend stocks as an acceptable choice for medium-term goals that can benefit from regular payouts, plus growth potential.
You Want Protection From Inflation
Long-term investments can also be better when your goal is to beat inflation or receive protection from inflation. Because long-term investments, like stocks, are often considered less safe than other assets, they provide a higher potential rate of return over time, allowing you a better chance of maintaining your purchasing power.
Another long-term strategy, Stein pointed out, is to buy I-bonds. These are Treasury bonds that have a fixed yield but also keep pace with inflation. In general, these bonds are designed to earn interest for 30 years, although you can turn them in earlier.
Note
An I-bond’s interest rate is a combination of a fixed rate and an inflation rate.
“I-bonds alone probably aren’t enough to completely fund retirement, but they can be part of a long-term strategy,” Stein said.
When to Pick Short-Term Over Long-Term Investments
Short-term investments, on the other hand, are those you plan to use to meet financial goals within a shorter time frame, according to Liebowitz. You might need the money to provide a stable income source, rather than to build your portfolio.
Short-term investments might include assets like bonds, cash, and annuities. There are some scenarios in which it makes sense to consider short-term investments.
You Know You’ll Need the Money Soon
When saving for shorter-term goals, like a down payment on a home, using short-term investments may make sense. Certain deposit accounts, for example, can provide a set rate of return (albeit a modest one, in most cases) and allow you to withdraw money whenever you need to.
“In general, these types of assets are considered less risky,” Liebowitz said. “You can keep money in a money market mutual fund or short-term bonds and reasonably expect to access that money for a shorter-term goal without fear of a market loss.”
Market loss is a key factor when you consider liquidity, which is your ability to access the dollars you invest. If you pick a volatile option like stocks, you may lose money when it’s time to withdraw your cash.
Note
Though deposit accounts offer stable returns, those returns (in some cases) might not outpace the inflation rate.
A CD ladder is another option if you need your money soon but want to earn returns in the meantime. However, know your financial institution’s withdrawal rules and penalties before you deposit your money. Some banks, for example, may require you to forfeit some of your earned interest if you want to close your CD before its term is complete.
You Want a Regular Source of Income
Short-term investments are often associated with a stable income. So, when you know you need regular income, shifting more toward highly-rated bonds and other assets can help. While the return isn’t as high as you’d potentially see with some stocks, you have a greater chance of income you can rely on.
“For some, annuities can fall into this category,” Liebowitz said. “While not for everyone, the right contract can help you with regular income for short-term needs.”
Annuities have their own set of pros and cons, though. For example, they can provide lifetime income, guaranteed growth (for fixed-rate annuities), and tax deferment, but they typically have high fees, surrender charges, and can cause tax issues.
Key Takeaways
Anytime you’re planning an investment strategy, you need to consider both long-term and short-term goals and choose investments that reflect your objectives. Finding balance is an important part of putting together a portfolio that works for you.
- Long-term investments are those that allow you to grow your portfolio and meet goals several years—or even decades—in the future.
- Short-term investments are designed for goals that are closer at hand and can provide access to returns considered safer.
- You should have a mix of long-term and short-term investments in your portfolio.
Frequently Asked Questions (FAQs)
What are growth stocks?
A growth stock is a share in a company that's expected to grow at a faster-than-average rate. These stocks typically don't pay dividends, because the companies are reinvesting their earnings to continue their growth.
What are index funds?
An index fund is a mutual fund or exchange-traded fund (ETF) that tracks a financial index like Standard & Poor's 500 Index (S&P 500), the Nasdaq Composite, and the Dow Jones Industrial Average. Index funds offer some diversity and low operating expenses, so they're a popular choice for IRAs and 401(k)s.
As an enthusiast and expert in financial planning and investment strategies, I bring firsthand expertise to guide you through the intricacies of long-term and short-term investments. My experience is grounded in a deep understanding of the concepts outlined in the provided article.
The article discusses the importance of knowing when to use long-term and short-term investments to grow wealth effectively. Long-term investments, such as stocks and real estate, are assets held for an extended period, offering growth opportunities. On the other hand, short-term investments, like bonds and cash, cater to shorter financial goals.
Let's delve into the concepts presented in the article:
Long-Term Investments:
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Retirement Planning (More Than 20 Years Away):
- Wendy Liebowitz from Fidelity Investments emphasizes that long-term investments, particularly stocks, are beneficial for individuals more than two decades away from retirement.
- Stocks, with their potential for growth, are suitable for building wealth over an extended period. Young investors have the advantage of recovering from market downturns.
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Planning for 7 to 10 Years in the Future:
- Financial plans for the next seven to ten years may involve medium-risk portfolios. Long-term investments, such as stocks, become more attractive during this period, according to David Stein, a former fund manager.
- Dividend stocks are suggested as an acceptable choice for medium-term goals, providing regular payouts and growth potential.
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Protection From Inflation:
- Long-term investments can act as a hedge against inflation. Assets like stocks, though considered riskier, offer higher potential returns over time, preserving purchasing power.
- I-bonds, Treasury bonds with fixed yields that keep pace with inflation, are recommended by Stein as part of a long-term strategy.
Short-Term Investments:
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Need for Money Soon (e.g., Down Payment on a Home):
- Short-term investments, including money market mutual funds and short-term bonds, are suitable for saving for shorter-term goals like a down payment on a home.
- Less risky options are preferred for short-term goals to ensure liquidity without fear of market losses.
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Regular Source of Income:
- Short-term investments are associated with stable income. Assets like highly-rated bonds and annuities can provide regular income when needed.
- Annuities, while offering lifetime income and guaranteed growth, come with their own set of pros and cons, including high fees and surrender charges.
Key Takeaways:
- Balancing Long-Term and Short-Term Investments:
- Achieving a balance between long-term and short-term investments is crucial for an effective investment strategy.
- Both types of investments play specific roles in growing a portfolio and meeting diverse financial goals.
FAQs:
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Growth Stocks:
- Defined as shares in companies expected to grow at an above-average rate. These stocks typically reinvest earnings for continued growth.
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Index Funds:
- Mutual funds or ETFs that track financial indices, providing diversity and low operating expenses.
In conclusion, a well-rounded portfolio considers both long-term and short-term goals, utilizing investments that align with specific objectives. Whether it's planning for retirement, achieving short-term financial goals, or understanding growth stocks and index funds, a comprehensive approach is key to financial success.
