We break down short-term investing vs long-term investing, and how your goals may affect how long you hold your investments.
A question that we get quite often is “how long should you hold your investments”? This will vary greatly depending on what your goals are, and how actively you want to manage your investments.
What is long-term investing?
Long-term investing is a method that involves holding onto your investments for a longer period of time. (Typically 1 year or more).
Many long-term investors are also passive investors. This means that they are not actively trying to buy and sell a ton within a short period of time.
Long-term investors may choose to invest in index funds, or companies that they believe in long term.
Investing for the long term is more of a “set it and forget it” method of investing.
What is short-term investing?
Short-term investing is a method that involves holding onto your investments for a shorter period of time. (Typically less than 1 year).
Short-term investors are often referred to as active investors, or active traders. This type of investing means that you are buying and selling within a short period of time. Sometimes a few months, a few weeks, and sometimes even within the same day.
Short-term investors are typically looking to profit quickly, and don’t plan on holding their investments long term. Essentially, they are trying to “time the market”.
Because short-term investing can be risky, many day/swing traders will also have a long term investing portfolio. They may choose to keep their retirement investments or other buy-and-hold positions in their long-term investing account.
Capital gains taxes
When you sell stocks, ETFs, bonds, real estate, etc – you will have to pay capital gains tax if you have made a profit.
You pay short-term capital gains if you have owned the asset for one year or less. This is taxed as regular income.
You pay long-term capital gains if you have owned the asset for more than one year. Typically long-term capital gains tax is lower than regular income tax rates.
If you’re uncertain about how capital gains work, consult with a tax professional. You can also read more about capital gains on the IRS website.
Common long-term investing strategies
There are some differences when it comes to the specific strategies for long-term investing. However the general theme is to “buy-and-hold”. Long term investors intend on buying and holding their assets for a period longer than one year.
These are a few of the common strategies used for long-term investing.
Value investing is a strategy that aims to pick stocks that are trading for a lower price than their intrinsic value. In other words, buying stocks when the price is lower than what it’s actually worth.
Many successful investors, like Warren Buffet, use value investing as their preferred strategy.
Value investing typically involves looking at a company’s fundamentals. For example debt to equity ratio, P/E ratio, profits, in addition to other information available in their annual and quarterly reports.
With value investing, you’re essentially investing based on what you believe the true value of the company is.
Growth investing is a strategy that involves investing in companies that have the potential to outperform the overall market.
This may be due to the company’s fundamentals, their management, innovation, an overall shift in consumer habits, or a combination of these.
Growth investing may seem somewhat similar to value investing. The main difference is that value investors look for undervalued stocks, whereas growth investors look for companies that have a strong potential for earnings growth.
Dividend investing is a strategy that involves buying stocks that pay dividends. Some people use dividend investing as a way to receive regular income from their investments.
Many times, these companies are referred to as blue-chip stocks. Blue chip stocks are companies that are dominant leaders in their respective industries. (Think of companies like Coca-Cola, Disney, Walmart, GE, IBM, and McDonald’s).
Often times, these well-established companies will pay dividends. A dividend is a small amount of money that you are paid for owning that company’s stock.
If you’re interested in getting started with dividend investing, M1 Finance offers some pre-built dividend portfolios. This can be a great option for beginners, or for people who would like a more hands-off approach to choosing their investments.
Common types of short-term investing
Short-term investors are typically looking to profit quickly in a short amount of time. It’s important to be aware that this type of investing often comes with additional risk and additional restrictions.
These are a few of the common strategies used for short-term investing.
Many short-term traders will use a strategy called technical analysis. Technical analysis relies on interpreting market behavior and price patterns of a company’s stock. This means reading the price, charts, volume, and indicators, as a way to predict how the price of an asset may move.
Scalping is a method of trading that involves a high volume of intra-day trades. Scalpers try to profit quickly off of very small changes in price. Their goal is to earn many of these small profits, hopefully adding up to a larger profit overall.
Scalping involves entering and exiting positions very quickly. If you are not using a commission-free brokerage, commission costs will eat into your overall profit.
Day trading is when you buy and sell assets (sometimes multiple times) within the same trading day.
Similar to scalping, the goal is to earn small profits on each trade. However day traders will typically make less daily trades than a scalper.
Day trading is typically a very big time commitment. Day traders need to actively watch the market to make the best decisions for their trades.
Swing trading typically occurs over a short to medium time frame. Swing traders may choose to hold a position for a few days, or a few weeks.
Unlike scalping or day trading, swing trading involves the risk of prices changing overnight or over weekends. Unfortunately this means that swing trading exposes you to the potential of price gaps – when an asset opens at a significantly different price after a night or weekend.
Swing trading does have some benefits over scalping or day trading. It requires less time, and may be a way to invest shorter term without as many restrictions on capital requirement.
Why is short-term investing harder than passive, long-term investing?
When we look at short-term investing vs long-term investing, one major difference is the time commitment.
Short-term investing means being a more active investor. This will take significant time on your part and means that you will need to always stay up to date with the current market.
Long-term investing is typically more passive. While you still want to stay informed about your investments, overall it will be much less of a time commitment. There are brokerages available like M1 Finance that even allow you to automate your investments.
There is always potential risk when investing. However, short-term trading may come with additional risks, and it is very common for day traders to lose money.
According to the SEC, “Day traders typically suffer severe financial losses in their first months of trading, and many never graduate to profit-making status.”
Read the SEC’s full article on the risks of day trading here.
3. Minimal capital
Scalping and day trading does mean that you will have to meet extra regulatory requirements. Executing four or more day trades within five business days will mark you as a pattern day trader.
This means that you will need have a certain amount of capital when using a margin account.
You can read more about the SEC’s margin rules for day trading here.
Depending on their goals, gifferent people will choose different investing strategies. If you choose short-term investing vs long-term investing, you may still consider investing in a long-term portfolio on the side.
Using a platform like M1 Finance is an extremely simple way to set up your long-term portfolio. M1 Finance makes it easy to automate your investments, leaving you more time to focus on the things you enjoy.