A Comparison of the Benefits and Drawbacks of Long-Term and Short-Term Investment Strategies
Friday, Feb 9, 2024
There are plenty of investment options out there to make that extra return for yourself. While the future is uncertain and inflation is a never-ending game, investing is a must to survive. If you have that extra urge to make more money than just surviving, investing is crucial at that point too.
So you get why you need to invest but regardless of you investing in small or any other type of investment you choose to put your money in, the term investing is done for a stipulated time to achieve the benefits later. The question arises whether you should do short-term or long-term investing.
Based on that decision alone you'll pick the instruments that serve your criteria and your strategies will also rely on that goal or decision of yours.
It's generally a balance of both short-term and long-term investment strategies, as it depends on your needs. The goal of making that extra money varies from person to person. However, the benefit of long-term investment strategies is just a cherry on top for any investor.
In this article, let's learn about both the benefits and drawbacks of each type of investment strategy to see what's good for you.
How does a short-term investment strategy work?
Any short-term investment strategies that exist, are all planned for not more than 3 years. It means the investor doesn't want to access this money for quite 3 years. Until that time while the money is working, the goal for such an investment can be anywhere like a down payment for a car or house purchase, a wedding, or travel plans and many such things.
While you know that you need the money in a short span, expecting a higher return like in long-term investments is unrealistic. But in that motive investing in a higher risk investment is also foolish because you are going for short-term investment for a reason that you need that money and in no conscious mind would you like to lose it.
So there are safer short-term investments that offer returns lower than long-term returns. Moreover, these investments will not have any lock-in period and can be liquidated in a short span.
Even if it allures to invest in high-return giving instruments during the short term, it is totally upon your risk level. For instance, during the financial crisis of 2008 in India where the BSE fell from 20000 to 9000, the correction took over a year and took about 20 months to recover. So if you had invested in a short-term instrument like stocks for 3 years, you wouldn't have seen any returns at all.
Not saying market crashes can occur every time but we never know, shouldn't you be safeguarding your money from any such event regardless of its occurrence? Diversification can help tackle the situation here as well.
How does a long-term investment strategy work?
If the goal is to buy a house not to pay a down payment, or is for retirement, kids planning, and many others, a long-term investment strategy is the only way you can achieve it. Because the goals are bigger and the strategy must be too.
The emotional knockout during a short-term investment can be avoided here as it's more like you buy and hold to walk by the waves. Any time more than 3 years to 10 years and more are long-term investments. You shouldn't care about this corpus for a long time. If that is the case, the instruments will be locked in longer and you must have a diversified portfolio where you have invested in multiple asset classes and not just one asset.
The risk here is to stay long in the game where you ignore the short-term volatility noise from your process and stay patient for the assets to grow at their own pace. Without diversification, you can't take the risk boldly, which always stands as a backup for anything worse.
The longer you stay invested here in the market the compounding action can do the magic too. As long as you don't remove your returns from the market and keep it reinvested the growth of your money is significantly higher than those who invest longer but don't reinvest.
That's where mutual funds and investing in smallcases can help in being disciplined, and consistent in seeing the growth.
Short-term investments can not experience the power of compounding but rather be involved in timing the market to make quick gains and continue doing so.
The benefits and drawbacks of short-term investment strategy
Here are the benefits that you can look at:
1. Flexibility
Flexibility is for cashing out the profits or capital without waiting longer. In case of unexpected scenes, this is easy to cash out by selling.
2. Quick gains
In a short span, the investor can make a good amount of profit for those who seek an alternative source of income. Hence the gains are most helpful for those relying on this source.
3. Less capital risk
The initial amount invested will be less and hence there is no major hit for the risk undertaken. Those who are averse to the long-term holding of capital can minimize it with short-term opportunities
The drawback on the other side:
1. Zero compounding effect
Though the quick gains are due to events occurring in the short span of the benefit of compounding over a long span is one factor that misses out. Hence the returns are lesser but quick gains are faster.
2. Risky market
The risks are everywhere and so is the short-term investment. Sudden changes in the market can always occur and without doing a proper analysis you can never enter an instrument.
3. Short-term capital gain tax
Anything money is an income, so tax is applicable here as well and is called short-term capital gain. Each type of instrument has different tax implications.
The benefits and drawbacks of long-term investment strategies
The benefit of long-term investing:
1. Averse to market bumps
In the event of market drops, the long-term investment strategy holds you together to look up for recovery which avoids taking losses.
2. Gives ample time to grow
The more time you give for the investment, the better returns it gives. Majorly compounding is one effect that plays here to do so and the other is staying averse to fluctuations to not take losses but rather keep growing.
3. Less charges to pay
The more often you buy and sell, the more you pay charges and this isn't the case in long-term investments. Comparatively, you pay but lesser charges.
4. Lesser emotions interrupt
This can be majorly experienced in long-term investments where your mind is well-informed of the long-term goals and doesn't allow emotions to take decisions for any fluctuations.
5. Beats inflation
Any investments you make must beat the inflation rate, otherwise the money you hold can seem less valued as inflation lowers the value of the money over time.
6. Tax benefits
Usually long term capital gain taxes are lesser compared to short-term capital gains. So you can have more of the profits with you. Also since you have held this for a long time, it can help in compounding for a long time without any tax.
The drawback is there here as well:
1. Investment gets locked
If you wish to liquidate the investment amount, you can't do so with long-term investments. In case there is any potential short-term opportunity, you'll have to miss it due to lock-in action.
2. Less exposure to other investments
If you have a huge corpus to investment in multiple assets, you can enjoy staying invested in the long term but if you have limited investment, then long term investment can limit your exposure to investing elsewhere
3. Potential risk
Be it long term, or short-term term potential risk is everywhere. Staying invested in one asset for a long time is the risk an investor takes in this strategy and the behavior of the market can't be predicted. Hence diversification is a must to tackle the risk.
4. Psychological triggers
In any situation in the market, the long term investor must stay psychologically sane to sustain the situation. That's quite a hard part when seeing the short term investors leveraging short term opportunities. It calls for being disciplined, patient, and consistent unlike short-term.
The Comparison of Short-Term Investment Strategy Vs Long Term Investment Strategy
Your investment goal matters a lot in deciding what strategy is apt to pick. While every individual essentially has both goals involved in financial planning, it is a balance of both to fulfill the goals. In that case, strategizing on the proportion of the investment is crucial, and learning about the risk profile of both types of investments is much needed.
While you are balancing both, keeping up with economic happenings, market trends, and news is the key and all this needs to be followed with discipline while also reviewing and adjusting the portfolio timely.
Be it as it may, keep emergency funds ready for any of your unexpected expenses rather than relying on the investment portfolio.
The Wrap
Long-term investment strategies have higher benefits than short-term investment strategies. It is mainly due to their ability to make more returns with compounding when invested in the right instrument, as it beats inflation, tackles market volatility, and keeps you less stressed above all.
One such long-term investment type that can benefit in reaching your long-term goal is investing in smallcase. A curated basket of stocks crafted based on an idea by SEBI registered managers. GreenPortfolio can cater to your personalized goals and investment needs with its carefully designed smallcases and portfolio management services. Get started with your financial journey on the right path. Explore the smallcase pricing here.
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