Sprints & Marathons – Investment Implications
Former GE chairman, Jack Welch said, “You can’t grow long-term if you can’t eat short-term.” That highlights an important distinction since investing is a cornerstone to wealth and financial success. With all the different investments and platforms available, it’s easy to jump in and out of the markets. But picking the suitable investments is where the rubber meets the road financially.
Before you begin analyzing the plethora of stocks, bonds, alternative assets, and charts, it’s essential to have a plan beforehand, even if it's a simple one, and determine your goals and timeframe. These two critical factors go hand in hand, each dramatically affecting the other.
Understanding the key differences between long-term and short-term investments is critical to your financial health as it pertains to timeframe. This conversation may help you focus on those differences.
A Crash Course in Timeframe
For starters, it’s important to note that while long-term or short-term can vary from investor to investor, there are official definitions to keep in mind.
In the world of investing for personal finance, long-term investments are almost universally known as any investment held for one year or longer. Short-term investments are those held for less than a year. In a broader financial-planning context, it might be better to stretch that time frame to something where the investments are held for 2-3 years, rather than one.
With that understanding, investments in each of these categories have stark differences in risk, fees, and, of course, returns.
Comparing Long and Short-Term
One commonality between long and short-term investments is that they are both designed to provide some form of return. Though the returns and risk levels can differ significantly, they are still investments and not 100% guaranteed. This also can mean that while they both may be taxable, possibly they are taxed at different rates.
Believe it or not, how long you hold an investment can determine the taxes you pay on any profits. You can be responsible for capital gains taxes when you sell an asset for more than you paid for it (this does not apply to investments inside retirement accounts). If you held your investment for more than a year, you must pay long-term capital taxes, usually at 15% although there are a few exceptions to this general rule.
If you held a stock, for example, for less than one year, the short-term capital gains are treated as ordinary income and taxed at your regular tax rate, which depends on all of your other income.
Long-term investments generally mean accepting a higher risk because there is more time for things to go wrong that can negatively affect your investment.
For example, a stock can have optimistic forecasts for the long term, but things can occur which create exceptions for one quarter, or one year. Witness the effect on energy stocks going into the recent pandemic that started in early 2020. They were trading in somewhat of equilibrium with a relatively positive long-term view based on supply-demand forecasts. Fast forward just 90 days into a shut-down economy and many of those leading stocks lost one-half of their value. At this writing, the supply-demand factors in a steadily re-opening global economy have meant the recovery of that loss and further growth. But, if you needed to liquidate your investment in the middle of that period, you faced a significant loss.
Even in the longer run, long-term investments have risk. Recessions can become extended, new competitors can emerge, and any other large-scale change can be challenging to forecast, therefore bringing more risk to investors.
Because of these risk factors, long-term investments tend to offer higher return potential, proportionately related to risk. If they did not, they could not attract capital for investment.
On the other hand, short-term investments typically have lower risk levels, and consequently, lower rates of return.
Importantly, investors must be aware of these differences when constructing their portfolios. Here’s how the timeframe comes into play with specific investments.
Investment returns can come in two ways. Either through capital appreciation (buying and then selling at a higher price), income (dividends, interest), or a combination of both.
Long-term investments typically rely more on capital appreciation for their total return. Short-term investments usually depend more on interest and dividend income to provide return. This means short-term investments can often provide cash flow and can be used as a haven to park cash (albeit for a short time). Bank CDs, short-term bonds, and money market accounts are examples of this. Though the rates of returns are low, these vehicles can be used to make short-term returns on your money while it sits on the lower-risk sidelines.
Some long-term investments can be used as cash flow generators, especially for retirees. While their returns can vary, bonds can offer fixed rates of return for several years at a time and pay interest every six months or every quarter.
Though cash flow can be had with both short-term and long-term investment vehicles, growth stocks should always be viewed as long-term investments. Here’s why.
Growth stocks are sometimes defined as companies that are somewhat new, although that is too limiting. A growth stock can be any company that hasn’t reached its mature size range and therefore may greatly expand in size and scope. These companies often pay minimal or no dividends to investors because the bulk of their cash flow is invested right back into the company itself.
Also, since these companies have room to run, their stock price may have the potential to double, triple, or more. But they can also lose steam and see their stock price drop swiftly. Therefore, stocks with this kind of volatility and risk are best held for the long run.
With a long-term viewpoint, investors can enjoy price growth over time. If the stock price falls, long-term investors have time to potentially recover (if the stock does). But since the price is likely to be volatile (both up and down), these do not make good investments for short-term goals.
How to Invest for Short-Term Goals
Remember, your investments should be positioned around your specific needs as an investor. If you have reason to believe that you’ll be using the money you're investing in about two to three years or less, then it may be best to hold short-term investments to protect your money.
So, what does this mean specifically?
Investing for the short-term means holding some of the investments mentioned above that offer very low risk. Money market funds, bank CDs, and short-term government bonds can be great choices.
Example: You’re only two years away from paying to send a child or grandchild to college. You probably already have many years of saving and long-term investments under your belt and have watched your wealth grow. But with such a short time frame before you’ll withdraw the money to pay tuition, you don’t want to put it at risk of a major contraction in value.
If the markets are hit with bad news like a recession, pandemic, or any other economic shock, long-term investments like stocks can get hit pretty hard. If your college savings account holds these investments, they’ll also get hit hard.
If you are thinking about goals like retirement, the Linscomb-Willams Retirement Countdown will help you get and stay on track.
Once you’ve reached the dollar amount you’re looking for, or once your ultimate goal for expending the savings is only a year or two away (or less), think about converting most or all of your long-term investments into short-term, low-risk vehicles.
Time is Money
A good financial advisor will always keep your timeframe at the forefront of their recommendations when recommending an investment strategy. Tailoring your investments between long-term investments and short-term investments (where needed) ensures that your risk level and investment goals are always aligned.
Think hard about your timeframe when making any investment. You’ll thank yourself later. Read about Linscomb-Williams specialized expertise, then connect with our investment advisors in Houston, TX today.