Short-Term vs Long-Term Investments

By Michael Flannelly · February 05, 2024 · 12 minute read

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Short-Term vs Long-Term Investments

Financial goals exist on a timeline. Some, like buying a new car, might occur within a year. Others, like retirement, may be decades away. Fortunately, short-term and long-term investments can help you achieve these different goals.

Read on to learn about long-term and short-term investments and the important considerations that come with each. Knowing the difference between long- and short-term investments can help you build a portfolio that suits your wants and needs.

What Is a Long-Term Investment?

A long-term investment is an asset or security expected to generate income or appreciate in value over a prolonged period, typically five years or more. However, for tax purposes, the Internal Revenue Service (IRS) considers long-term investments to be investments held for more than a year.

Brian Walsh, a CFP® at SoFi explains that long-term may be defined a little differently when you’re thinking about saving. “A long-term goal is really going to be anything that’s more than seven years out. So a lot of times, we think of common long-term goals as retirement, maybe saving for a kid’s education, or maybe buying a house.”

Long-term investments often gain value slowly, weathering short- to medium-term fluctuations in the market.

Investors usually build long-term investments into balanced portfolios that consider their goals, risk tolerance, and time horizon. Usually, investors hold these investments for a few years or more to help fund long-term goals, like retirement or saving for a child’s college education.

Any investment can be a long-term investment, but the foundation of a long-term investment portfolio is typically a mix of stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Long-term portfolios may hold other assets, such as REITs (real estate investment trusts).

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

What Is a Short-Term Investment?

Short-term investments are assets that investors hold for less than five years. Investors typically use these investments to help fund short-term financial goals, such as saving three to six months’ worth of expenses in an emergency fund, saving to buy a new car, or saving for the down payment on a home.

Investors can hold almost any investment in the short term, including stocks, bonds, and ETFs. Many investors trade these assets in short periods, like days, weeks, and months, to profit from short-term price movements.

However, these assets can be risky and volatile, resulting in losses in a short period. Therefore, investors consider less risky investments, such as certificates of deposit (CDs), high-yield savings accounts, or short-term bonds, if they want to invest in assets that will provide stable returns in a short period.

While these investments may not offer the potentially higher returns of investing in the stock market for the long term, they make it more likely an investor’s money will be there when they need it in the short term.

In fact, certificates of deposit and high-yield savings accounts are FDIC insured for up to $250,000.

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Long-Term and Short-Term Investments: The Differences

As mentioned above, long-term and short-term investments have several differences. For example, investors typically buy long-term investments to hold for many years, only selling the assets when they need the funds. In contrast, investors usually make short-term investments to get a return within a period as short as a day and as long as three years.

Another difference is that long-term investments like stocks are often volatile, whereas short-term investments like certificates of deposit or high-yield savings accounts generally provide stable returns.

Additionally, the IRS taxes the gains on long-term and short-term investments at different capital gains tax rates.

Long-Term and Short-Term Investments: The Similarities

Investors use both long-term and short-term investments to build wealth, which is the main similarity between the two types of investments.

Additionally, long-term and short-term investments each involve some degree of risk; there are no guarantees with any investments.

What About Day Trading?

As mentioned above, some investors trade assets, like stocks, ETFs, and options, in short time frames to profit from volatile price movements.

Day trading is a style of this short-term investing, where investors hope to buy and sell a stock for a modest profit, usually within the same day. By nature, day traders are exploiting volatility in the stock market. As stock prices fluctuate throughout the day, they hope to capitalize on upswings, buying low and selling slightly higher.

While it may sound exciting, day trading is not appropriate for most investors. That’s because the profits for day trades can be relatively small, and investment fees and taxes can eat into even those modest profits.

While investors can turn a profit by day trading, it’s equally likely that they will lose money.

What’s more, day traders are competing with professionals who have lots of sophisticated tools and information at their disposal to help them succeed. These professionals are often moving large sums of money and attempting to turn a profit on tiny gains. Even these experts fail to time the market much of the time.

Long-Term Investing and Compounding Interest

Compound interest refers to the interest that accrues on savings accounts, including high-yield savings accounts, CDs, and money market accounts. The interest accrues both on the principal balance in the account and on the interest earned so that your money grows faster. Over time, the effect is typically amplified.

To get a clearer idea of how compound interest works, investors can use a compound interest calculator to input the starting balance, regular contributions, and interest rates.

Compounding returns, on the other hand, may be one of the more powerful tools available to investors. They are why even seemingly small amounts invested today can go a long way in the future. Stocks, mutual funds, and ETFs are some of the types of investments that may earn compounding returns.

The idea is simple: investments hopefully earn returns, and when those returns are reinvested, they may also start to earn returns. As a result, investor’s savings might grow at an exponential rate. Of course, there is no guarantee that any investment will earn a high rate of return. And investments that may potentially earn a higher return also tend to be higher risk.

While compounding returns typically begin to work as soon as an investor starts to invest, the benefits are long-term in nature. The longer the investor can allow their returns to compound, the more money they may be able to make.

As a result, investors may want to consider compounding as more a part of a long-term investment strategy than a short-term strategy.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Tax Differences Between Long- and Short-Term Investments

The federal government charges different capital gains tax rates on investment profits depending on how long an individual holds their investments.

Investments sold after more than a year are subject to the current long-term capital gains rate, which is equal to 0%, 15%, or 20%, depending on an investor’s income and the type of investment.

The long-term capital gains rate might be much less than the investor’s income tax rate, which can help incentivize investors to hang on to their investments over the long run.

Investments sold in a year or less are subject to short-term capital gains. The short-term capital gains are taxed as regular income and are determined by an investor’s tax bracket.

Investors considering short-term investments of less than a year should be sure to factor in the cost of paying the higher short-term capital gains tax rate.

Recommended: Everything You Need to Know About Taxes on Investment Income

Capital Gains Tax Rates

Long-Term Capital Gains Tax Rates for 2023 (for Tax Season 2024)

Tax Rate

Single

Married Filing Jointly

Married Filing Separately

Head of Household

0% $0 to $44,625 $0 to $89,250 $0 to $44,625 $0 to $59,750
15% $44,626 to $492,300 $89,251 to $553,850 $44,625 to $276,900 $59,751 to $523,050
20% More than $492,300 More than $553,850 More than $276,900 More than $523,050
Source: Internal Revenue Service



Short-Term Capital Gains and Income Tax Rates for 2023 (for Tax Season 2024)

Tax Rate

Single

Married Filing Jointly

Married Filing Separately

Head of Household

10% $0 to $11,000 $0 to $22,000 $0 to $11,000 $0 to $15,700
12% $11,001 to $44,725 $22,001 to $89,450 $11,001 to $44,725 $15,701 to $59,850
22% $44,726 to $95,375 $89,451 to $190,750 $44,726 to $95,375 $59,851 to $95,350
24% $95,376 to $182,100 $190,751 to $364,200 $95,376 to $182,100 $95,351 to $182,100
32% $182,101 to $231,250 $364,201 to $462,500 $182,101 to $231,250 $182,100 to $231,250
35% $231,251 to $578,125 $462,501 to $693,750 $231,251 to $346,875 $231,251 to $578,100
37% More than $578,125 More than $693,750 More than $346,875 More than $578,100
Source: Internal Revenue Service

Finding the Right Approach

Whether an investment is meant for the short or long term can significantly impact whether an investor chooses an active or passive investment strategy.

Active Investing for Short Term Goals

Active investing is a hands-on investment approach and often goes with a short-term investment strategy, like day trading.

Active investing might mean hiring an investment manager who will handpick investments, buying and selling them in a short time frame to try to beat the market. Because of their active involvement, these managers often charge relatively high fees.

Individual investors may also pursue this strategy, choosing investments and deciding when to buy and sell. This approach can be much cheaper than hiring a professional.

An active strategy may work well for an individual saving for a near-term goal who wants the flexibility of being able to choose specific financial instruments, such as short-term bonds, to help them save.

However, an active investing strategy to make short-term gains is risky and not appropriate for all investors.

Passive Investing for Long Term Holding

Passive investing is a relatively hands-off strategy in which investors attempt to match the movement of a market index, often by using mutual funds, ETFs, or index funds.

For example, some funds might track the S&P 500, owning all of the companies tracked by that index at the same proportion and percentages they make up there.

Passive investments are not necessarily trying to capitalize on short-term movements in the market. Instead, they are trying to track the market over the long run. Passive investment strategies often come with low or no fees.

Any index is likely to experience ups and downs. Investors taking a long-term approach may have time to ride out rocky patches.

Holding Short-Term vs Long-Term Investments

Investment time horizon can also play an important role in where an investor holds their investments. Invests can open short-term investments such as CDs and high-yield savings accounts with a bank.

Short-term investors will need to open a brokerage account to trade stocks and other securities. Investors can place orders to buy and sell stocks and bonds online or by phone through a broker.

Brokerage accounts are taxable, meaning that any gains an investor makes are subject to capital gains taxes. Investors can sell securities and withdraw their funds at any time.

Long-term investors may want to consider several investment accounts, including a brokerage account, to help meet their long-term goals.

Long Term Investing with a 529 Plan

An investor saving for a child’s college education might consider a tax-advantaged 529 savings plan. Parents, as well as extended family and friends, can contribute to 529 plans. Funds inside the account can then be invested in various investments, including mutual funds and exchange-traded funds.

Investments grow tax-free inside a 529 account and are not subject to capital gains tax. Withdrawals from the account are also tax-free as long as they are used to cover qualified education expenses, such as tuition, room and board, fees, and books.

Withdrawing the money for other reasons can subject investors to income tax and a 10% penalty on earnings.

Long Term Investing with a 401(k)

Retirement is perhaps the ultimate long-term goal for many investors. The government is very interested in incentivizing you to save for this period of your life, so they provide many different options for savings accounts, including employer-sponsored 401(k)s.

Traditional 401(k)s are employer-sponsored plans that allow eligible employees to set aside a portion of their pre-tax paycheck into an investment account. They can usually invest their funds in a limited suite of investment options, such as mutual or target-date funds.

Investments grow tax-deferred, which may supercharge growth when combined with the power of compounding returns.

After age 59 ½, investors can make withdrawals, which are subject to income tax. Withdrawals before that age are subject to income tax and a 10% penalty, although there are some exceptions to that rule.

Retirement Options other than a 401(k)

Workers who don’t have access to a 401(k) — or those who do and want to save more — may want to consider a traditional or Roth IRA to invest in for retirement. Investors can fund traditional and Roth IRAs up to certain limits and invest the money however they want.

Traditional IRAs are funded with pre-tax money. Funds grow tax deferred and are subject to income tax once withdrawn after age 59 ½. As with 401(k)s, withdrawals made before this point are subject to income tax and a 10% penalty.

Roth IRAs, on the other hand, are funded with after-tax dollars. Investments inside these accounts grow tax-free and are not subject to income tax once withdrawn after age 59 ½.

Each of these retirement accounts potentially ties up investors’ money for decades, and early withdrawals are subject to stiff penalties. They should be considered chiefly as long-term investment tools.

Deciding Between Short-Term vs Long-Term Investments

A mix of long- and short-term investments can lead to a diversified portfolio that can help investors achieve financial goals. This is especially true if you invest in long-term assets, like stocks and ETFs, for retirement or long-term savings. You can use short-term investments, like CDs or a money market account, to fund a vacation or build up an emergency fund.

However, if you are looking to make short-term profits through trading securities like stocks, ETFs, or options, you have to make sure you have the risk tolerance and time to take on this strategy. Most financial specialists do not recommend that investors take on this strategy.

Start Investing With SoFi

Once you’ve decided on long-term or short-term investments or a mix of both, you’ll need to open the appropriate accounts in order to begin. For instance, you can open an online IRA if that’s something you’re interested in, or open a brokerage account to trade assets like stocks and ETFs.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What are the differences between long-term and short-term investments?

The main difference between long-term and short-term investments is the time each type of investment is held. Long-term investments are held for years, while short-term investments are held for days, weeks, months, or a few years. Additionally, long-term investments take longer to mature and have more risk, while many short-term investments, such as savings accounts and CDs, are often less risky.

What are the similarities between long-term and short-term investments?

The similarities between long-term and short-term investments are that they are both types of investments, and they both have the potential to help investors build wealth. In addition, they each involve some degree of risk.


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