The Pros and Cons: Long Term versus Short Term Investment

As an investor, your investment strategy should take into account various factors, one of which is the length of time that you are willing, or able to, invest for. There are pros and cons to each.

What is long-term and short-term investment?

Long-term investments is defined as “accounts on the asset side of a company’s balance sheet that represents the investments that a company intends to hold for more than a year. They may include stocks, bonds, real estate and cash”. The same is true for individual investors.

The long-term investments account differs largely from the short-term investments account in that the short-term investments will most likely be sold, whereas the long-term investments may never be sold.

A common form of this type of investing occurs when a company invests largely in another company and gains significant influence over that particular company without having a majority of the voting shares. In this case, the purchase price would be shown as a long-term investment.

Buying and holding a certain stock or bond for a long time is not necessarily long-term investing. Long-term investing is like buying Facebook in the anticipation that Facebook will rise and dominate the social networking industry in the future (as illustrated above).

A short-term investment account on the other hand is defined as “an account in the current assets section of a company or an individual investor’s balance sheet. This account contains any investments that a company or individual has made that will expire within one year. For the most part, these accounts contain stocks and bonds that can be liquidated fairly quickly.”

Most companies in a strong cash position have a short-term investments account on the balance sheet. This means that a company can afford to invest excess cash in stocks and bonds to earn higher interest than what would be earned from a normal savings account.

Microsoft, which is always in a strong cash position, had short-term investments totaling approximately $32 billion at the end of 2005.

That’s the nerdy definition. But what is the better choice?

For starters, it depends on your goals, and your tolerance to risk. Nonetheless, let us lay down the general advantages and disadvantages of both short-term and long-term investing.

General Advantages and Disadvantages of Long-Term Investment

Greater return on your investment. Investing over the long term generally ensures capital increase over a long period of time. The interest you gain from your original capital amount can be capitalised again; meaning you can add the interest earned to the original capital amount. A long term investment is typically more stable as you can reap the benefits of improved interest rates and market conditions.

Access to your funds. Another thing to consider in investing is the ease with which you can access your funds. If you choose a long term investment and then need your funds, there are often penalty fees which you would need to pay. If you think that you may need to use the cash that you are investing, rather choose an account that allows you to access your funds without paying hefty fees.

Capital requirements. Time is not on your side if you invest over the short term. In this case, it is better to choose an investment where your capital amount is guaranteed. You will therefore have the certainty that you will not exit the investment with less money than you originally invested. Choose long-term over short-term investment if you cannot stand having time not on your side.

Long term peace of mind. One of the benefits of having a longer term investment is that you are able to invest and don’t have to worry about what to do with the funds. You can invest for the required time period and let your money do the work. Long term investments generally show a steady growth pace over a long period of time. This lends to long term stock investments being a more stable and less risky investment than the short-term stock.

The Pitfalls: There is the risk of having less control over your money due to the long period of time it takes for the stock to mature. Another disadvantage to long-term stock investing is how long it will take to see any profits. If you are in need of money immediately, long-term stock investments may not be the route for you.

General Advantages and Disadvantages of Short-Term Investments

The main advantage of short-term investments is their growth potential in a short period of time. You can ride short-term spikes in your stock’s market value. Short-term investing can give you more control over your money as you buy and then sell within a short time period.

The Pitfalls: A volatile stock market can make a dramatic change to a short-term, trendy stock (characterised by sudden spikes and unpredictable downfalls). These types of stocks are affected by unpredictable circumstances due to the short time period. In addition to the possibility of making a good amount of profit in a short period of time, alternately, investing in short-term stocks can also lend to losing a great deal of money in a short period of time. So be aware that the risk goes both ways.

The Bigger Perspective

Your friends be like: “Buy and hold investments!”, “Ignore short-term market dips because long-term investment means sure gain in the long-term making it less riskier compared to short-term investments”. Well, they are right. But they could also be wrong.

When stocks decline to zero, a buy-and-hold investor would most probably regret skipping selling opportunities that would have preserved cash. That’s because they don’t prefer short-term investment decisions!

Short-term investors hold investments for one to three years and ride short currents in the marketplace. This approach results in some exciting gains when you are right, but can deplete your portfolio if you’re wrong.

So, the real question really is not about choosing and dedicating your investment effort to just one investment technique. Here’s why:

High Short-Term Gains

If a stock has sudden gains, you must make an estimate of its ability to sustain those gains. For example, if you hold a stock that shoots up 20 percent, look ahead and ask yourself whether market volatility will bring it back down. The markets seldom average a 20 percent gain in a year, so you are already ahead in this example. You can lock in a gain now and repurchase the stock if it drops to a cheaper price.

Moderate Long-Term Gains

Stocks that tend to grow slowly qualify as long-term possibilities for a portfolio. These stocks tend to be less volatile. This approach will not produce current income, but it may build your retirement funds steadily.

So, it means, your decision to choose long-term over short-term investment depends on the character or behavior of the stocks you choose, your financial security, and your tolerance to risk, and also, your goal (high-risk instantaneous profit, or less risky long-term steady money build up).

A Hybrid Approach

The most important thing to consider when you are trying to decide which investment type is for you is your reasons for investing. If you are investing in stocks in order to make money quickly, then clearly a short-term investment plan is for you.

However, if your investment or stock trading strategies are to save for the future then a long-term plan may be best.

But here’s the thing: You can mix short-term and long-term investments in your portfolio! \

Many investors do this by allocating a percentage of cash that shouldn’t be placed at high risk. The part of a portfolio they want to protect can go into long-term investments that appear to be lower-risk investments.

While you never have a guarantee that you won’t lose money, a long-term investment in a steady company’s stocks may have a greater chance of moderate growth with moderate risk.

The riskier part of a portfolio can work in short-term investments. This method allows for greater potential for gains, but if you choose this method, you must tolerate increased risk on your short-term investments.

Regardless of what you decide, investing today in the stock market requires sound planning, research, and investment strategy in order to make the best buys and sells you can. In the end, your investment success depends upon your willingness to take calculated risks and staying on top of your trades to ensure you follow the strategy you have decided upon.

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