When it comes to charting out your investment portfolio, the first thing you need to do is be very clear of the financial objectives you’re trying to achieve from making those investments.
Based on that, the next decision would be to decide whether a short term or a long term investment would help you achieve those goals. It’s important to remember that Short-term and long-terms investments are both important in their own way as they fulfil different purposes in your financial journey.
Here are some very important things to keep in mind while deciding the way forward for your investment portfolio.
The first step before you make any investment-related decisions is to consider the 3 most important factors - your financial goals, duration of investment and your risk-bearing appetite. The next step is about choosing the right investment instrument. The strategy you adopt before you go ahead with your investments is completely dependant on these factors.
But before getting into the decision-making process, let us first understand the definition of short-term and long-term investment.
What are Short-Term Investments?
Short-term investments are investments in instruments where you earn your returns within a period of three to five years. Short-term investments are suitable for investors who’re trying to save taxes or earn a return on investment of some per cent, without actually expecting the investment amount to grow multifold.
What are Long-Term Investments?
Long-term investments are chosen with a more distant financial goal in mind. The idea is to grow wealth over a long period of time, ignoring the fluctuations in the markets caused over a shorter period. Long-term investments are usually made for many years, sometimes even decades. Hence, a return on these investments can only be expected to be realised over a very long stretch of time.
The Relation Between Financial Goals and Investments
Long-term and short-term investments vary depending on the end goals they help investors achieve.
While short-term investments plans focus more on near-future goals, long-term investments are done to fulfil financial goals in the distant or far future.
For example, saving money to pay for a home loan down payment can be a short-term goal, whereas planning to buy a house without taking a loan can be considered a long term financial goal due to the rising costs of real estate.
When it comes to short-term investment plans, the expectations are low, since investments and the interest accrued does not compound over time. There is a fixed or variable interest which is applicable, and the interest generated or the returns earned is rarely multifold of the initial investment amount.
On the other hand, long-term investment can provide returns which are way higher than the invested amount. This is possible through the power of compounding. Most financial advisors recommend investing in such instruments where compounding occurs, for more than 15-20 years since the interest earned can be reinvested to earn more interest which in turn generates returns much higher than the principal amount invested in the investment instrument.
Hence, this helps in generating wealth, which is one of the primary expectations from long-term investments.
Risk Factors Involved in Both Types of Investments
In the case of short-term investments, market conditions and the country’s financial system play an extremely important role and can affect the returns you earn through your investments. However, when it comes to long-term investments, inflation plays a major role since if the returns promised through the investments are not higher than the expected rate of inflation, then the investments will be of no use because the invested amount’s worth and returns earned would be much lesser than the value of the amount after a long period of time.
How to Balance Long-Term and Short-Term Investments
We’ve observed the differences between long and short-term investment plans, but it’s important to remember that they are both equally important in building your investment portfolio. They can also be combined in a portfolio.
A key rule of thumb to remember is that short-term investment plans tend to be riskier and therefore need to be carefully thought out.
Long-term investments should be done with the money that you’re saving for future goals, such as retirement or buying a house in the far future.
So when you’re planning your investments next time, evaluate your goals and then decide which type of investment you should move forward with. But be sure to only allocate a portion of your money to short-term investment plans with which you’re willing to bear some risk. With this in mind, the major portion of your investments should be considered for long-term investments. With this, you get the best of both worlds.
So, there you have it. In this article, you’ve learnt what short-term investment and long-term investment means, how financial goals can influence the decision-making process, the risk factors involved and how to strike the right balance between the two types of investment. We hope that the next time you plan investment, you’ll be able to be a better judge at choosing short-term vs long term investments.