There are two ways to understand the difference between short term and long term investments.
The definition is simple. A short term investment is any asset you hold for one year or less. Most investors hold short term investments for no more than a few months at a time, if not several weeks. A long term investment is any asset you hold for more than one year. Most investors hold long term investments for several years as part of an overall strategy for their portfolio.
Now for the long version.
What Is Short Term Investing vs. Long Term Investing?
Short term investments and long term investments are distinguished by how you use them. A stock will be a short term investment in the hands of a day trader who sells it within a few hours. When held in a 401(k) for several years, that same stock would be considered a long term investment.
Common Profile for a Short Term Investment
As noted above, short term investments are financial instruments that you hold for less than a year. Most traders will hold a short term investment for several months at the most, looking to profit off volatility and near-term gains.
While any asset can technically be a short term investment, most will share a few common features. They will typically be volatile assets, letting the price move quickly enough for investors to profit off the asset within a brief period. They will generally have relatively small price movements. Finally, a short term investment will also generally be highly liquid, allowing investors to sell the asset fairly quickly.
In particular, day traders and active traders often hold significant short term investments.
Common Profile for a Long Term Investment
Long term investments are financial instruments that you hold for more than a year. Most traders hold these investments for several years at a time, building them into portfolios with a specific strategy, such as 401(k)s, college funds and long term savings accounts.
As with short term investments, any asset can be a long term investment. However common long term investments gain value slowly but predictably, making them better assets to hold over several years. Investors will also usually hold illiquid assets as long term investments.
The most common long term investment is real estate. Many people buy homes as an investment that they will hold for years, if not decades, allowing the property to accrue value. The process of buying and selling a house, which makes this investment very illiquid, would make this a difficult short term investment but is less of a problem over a period of years.
Other common long term investments include many mutual funds and bonds.
Long term investments are common for most retirement accounts and college funds, portfolios which tend to trade relatively rarely and count on long term growth.
The Role of Short Term and Long Term Investments
Short term and long term investments play different roles in a portfolio. A few of the more common strategic differences include:
Short term investments trend toward more volatile assets than long term positions. While volatility isn’t necessarily a benefit for investments that last years, short term traders generally rely on it to realize a profit.
Short term investments tend to seek out positions that will gain or lose less value than long term investments. A trader has less time for a short term investment to regain any value that it loses, so they tend to look for safer products which will post some gains in the immediate future. Traders who hold short term positions tend to try to make up for smaller gains by making more frequent trades.
Note that day traders are a common exception to this rule. They tend to look for high volatility swings, capitalizing on sudden price movements in an asset over a course of hours.
Long term investments can take a more aggressive position than short term ones, because they can better afford losses. An investor who plans on holding a particular asset for several years has time to recover any lost value, which can often happen with aggressive or risky investments. Short term investments have considerably less room for this kind of error.
Passive vs. Active Investing
Active investors often hold short term positions. These traders move their products fairly often, which by definition tends to make their assets short term investments. By contrast passive investors generally buy and hold their assets for longer periods of time. Again, by definition, this tends to make their assets long term investments.
Immediate vs. Horizon Goals
Finally, investors tend to choose investments based on their goals.
Investors who have immediate goals will generally hold short term investments. For example, professional traders often hold short term investments if they live off the profits that their trading generates. In this case, the investor’s goals will be to make income within the next week or month. Other investors might want to add a little value to a vacation fund or save up for a nicer car. All of these positions will likely close out within the coming year, and as a result will generally be made out of stocks, options and other short-term positions.
Then there are the investors with “horizon” goals. These are investors who are saving and trading for something far in the future. Retirement accounts are a common example of a horizon goal as, increasingly, are savings for a down payment on a house. An investor won’t close this position out within the next year. Instead, they’ll hold this portfolio for many years to come. It’s common to fill that portfolio, then, with long term investments that grow over time.