In this article, the differences and significance of short and long term investments have been explained, along with the practical implications of adopting each method of investment.
The concepts-‘short-term’ and ‘long-term’ are classifications of investments based upon their time period. The word ‘term’ principally states the time duration. Now, there are no exact definitions for long-term and short-term. There is no official figure, in the form of number of days, months, or years that can be used to define or state a said investment to be long or short. Instead, the definition is often based on common connotations and several meanings, which have been stated by different companies, governing bodies, and investment experts.
While understanding the difference between the two types, establishing a logical and proper timeline and segregation of the two concepts is quite difficult. However, here’s a brief explanation on the abstract time differences.
Meaning and Definition
From the point of taxation and legal perspective, a short-term investment is the one that does not exceed 12 months or one singular accounting year. On the other hand, investments which exceed more than 12 months are long-term ones. You will need to use this logic and difference in official documents, and while filing income tax returns or declarations of investments.
Please note that investments, which are subject to immediate liquidation, such as stocks, money market instruments, and also Forex currency are subject to the same logic. That is, if your buying and selling transactions have taken place within those 12 months, then you will have to deem these investments to be short-term ones. However, if the time period between the two transactions is more than 12 months, then you will have to claim the investments as long-term ones.
Apart from the 12-month rule, there are some different definitions, which are forwarded and followed by people. For example, for the fund-based investments, such as annuity, insurance, and mutual fund, a fund which has a 5-7 years time period, is said to be a short-term investment. On the other hand, funds exceeding 5-7 years time span are said to be long-term investments.
There is a genuine difference in the applicability of long-term and short-term investments. The primary difference is that the long-term investments tie you down, compelling you to take up payments for a very long time, though in the later stages of such investments, the returns are rather handsome. Have a look:
- In practical application, stocks and Forex, with some minor mutual funds, are considered to be short-term investments. The rule of thumb says that more the investment, more is the rate of return going to be. On the other hand, long-term ones such as mutual funds, insurance, annuity, collective investment schemes, and even a mortgage loan have a longer payment structure and an even longer maturity period. They have a relatively low payment/investment volume, but the returns are substantial.
- Depending upon the instruments, short-term investments are more risky, since a larger volume of money is put at stake and there is no hedge or cushion for such a risk. On the other hand, long-term ones are professionally managed and tend to have a cushion or hedge, which prevents losses.
- The percentage return-on-investment for a short-term investment tends to be higher than its long-term counterpart.
On the whole, for individuals, it is better to have more (preferably two) long-term investments and a few short-term ones, as per the situation.