Long-Term vs. Short-Term Investment Strategies

Investing requires both long-term and short-term strategies: goals that are a few months down the line, as well as decades down the line.

Long-term investments are most commonly used to save for events at least five or 10 years into the future. Short-term investments are for events that are likely to happen within the next five years. 

Based on your time horizon and goals, you’ll decide how much risk to take on. But generally, you want to park your short-term investments in safe, liquid accounts, while long-term investments can typically handle higher risk to potentially earn greater returns.

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Difference Between Short-Term and Long-Term Investments

Knowing how long you expect your money to be invested affects the way you invest it. 

With any investment, you need to think about your time horizon, which is how long until you’ll withdraw funds. 

For example, you may need to access your money to replace a vehicle within two years. That’s a short-term investment, so you need to keep that money safe (where it won’t decrease in value) and liquid (easily accessible). 

But long-term investments remain invested for several years and you can take a bit more risk. 

Note: The IRS has a different definition that impacts you at tax time. Short-term investments are those you hold for less than one year before selling, and long-term investments are those held for more than one year. Short-term investments get taxed at your ordinary tax rate.

Long-term investments	Short-term investments
Illiquid (you can’t access it easily)	Liquid (easily accessible)
More volatile/may lose value	Possibly more stable rate of return and can be FDIC-insured
Will stay invested for at least five to 10 years	Will be invested for under five years
Compound interest has a greater impact	Compound interest works but to a lesser degree
IRS levies lower capital gains tax rate on investments held for at least one year	IRS taxes investments sold within one year at the higher short-term capital gains tax rate

READ MORE: What Are Short-Term vs. Long-Term Capital Gains?

Long-Term Investment Examples

Long-term investment funds are for when you want to put your money away and leave it alone for a long time — that could be six years, or 15 years, or 42 years. 

You might take more risks because you have time for your accounts to recover from any downturns in the market. 

With long-term investments, “Over time you experience the magic of compound growth — it gets bigger and bigger like a snowball rolling down a hill,” says Jeremy Schneider in an Erika Taught Me podcast interview. 

Your investment continues growing because you’re leaving it invested for many years. 

Index funds

Schneider says the majority of his wealth lies in index funds. 

You can invest in index funds via your 401(k) or another stock-based account. 

Index funds are mutual funds or exchange-traded funds (ETFs) that mimic the performance of a specific financial market index. 

For example, the S&P 500 tracks the performance of 500 of the largest companies on U.S. stock markets. You likely wouldn’t hand-pick that many stocks to invest in individually, but by buying into an index fund tracking the S&P 500, you get exposure to this wide range of companies. 

401(k) or 403(b)

Employer-sponsored retirement accounts are great for long-term investing. You’ll arrange to withhold a portion of your salary each paycheck that then goes into your 401(k). 

These often come with tax advantages — the traditional 401(k) offers tax-deductible contributions, while the Roth 401(k) contributions are taxed but your withdrawals are tax-free. 

READ MORE: What Is a 401(k)? Comparing Roth vs. Traditional Plans

Individual Retirement Arrangement (IRA)

Another way to invest in stocks is through a traditional IRA or Roth IRA, which is especially helpful if you don’t have an employer-sponsored plan like the 401(k). 

IRAs are meant for retirement (of course) and you can contribute up to a maximum annual amount and let your money grow until age 59½. 

529 Plan

The government’s 529 Plan allows you to save for a child’s education with some tax advantages. Earnings grow tax-free in 529 plans, plus the withdrawals are tax-free as long as the money is used for qualified educational expenses. 

If you start this account when your child is born, you’ve got 18 years to let that money grow tax-free. 

Real estate

Buying property, especially income property rather than the home you live in, is a long-term investment. You should approach this carefully since it’s not always easy to sell property for what it’s worth to you when you need the money. 

There’s quite a bit to consider before investing in real estate. You’ll want a property that you can feasibly manage for the long haul. If dealing with actual physical property is too much at first, you can dip your toe into real estate through REITs, or real estate investment trusts. 

Short-Term Investment Examples

Short-term investments are those you’ll need to get your hands on within five years, and many are even needed within one or two years. 

You want to avoid taking on risk with these, so be sure your investments won’t lose value and you can pull your money out when you need it.

Certificates of deposit (CDs)

This is an account that you open at a bank (online or brick-and-mortar) that pays a fixed or variable interest rate. 

You choose the term, which is often between three months and five years. You should not withdraw the money until the CD matures — otherwise, you’ll forfeit some of the interest earned as a penalty. 

READ MORE: Are CDs Worth It?

High-yield savings accounts (HYSAs)

Technically, these are savings accounts, but many online banks pay a decent interest rate on your savings in high-yield savings accounts — which makes them a great place to park short-term investments. 

For example, you can use HYSAs to save for a down payment without worrying about your money losing value.

Money market funds

For short-term investment goals, you can also use money market funds. 

These are mutual funds invested in securities that are fairly low-risk, making them useful for investing for shorter periods of time since they’re both stable and liquid.

READ MORE: Money Market vs. Savings: Which Account Is Best for You?

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When to Choose Long-Term vs. Short-Term Investments

How do you know whether you’re looking at long-term or short-term investments? 

Here’s how to decide, and how that impacts where you invest your money. 

Invest long-term if…

… you need to invest for your retirement and anything that is at least five to 10 years away. 

Of course, if you’re 25 years old, there’s a big difference between a 10-year investment and investing for retirement that could be three or four decades away. 

Long-term investments are most commonly used to save money for retirement and other major future expenses. Children’s college is also up there as a key long-term investment need.  

Basically, if you don’t intend to access the funds for a long time, you should use long-term investment strategies. 

READ MORE: How Much You Need to Retire

Invest short-term if…

… you need the money within a few months or up to around five years. 

The best way to invest money short-term is to find an account that provides growth potential while also making it easy for you to pull your money out as needed. 

Think of short-term investments as “savings” goals rather than attempting to predict the next “big” stock with a big payday. 

Short-term investments are ideal for a house down payment, a vacation fund, or saving for your next car.

FAQs

How long is a long-term investment?

There’s no fixed definition, but typically you can consider something a long-term investment if you hold it for at least five to 10 years. 

The key is that you don’t intend to access or withdraw these invested funds for a significant length of time, whether that’s 10 years or 50 years. 

Which investment has the least liquidity?

When your money is liquid, it’s readily available to you when you need it. Funds in your checking account are liquid, but many investments are not. 

If you own real estate, that’s probably the least liquid investment because you can’t easily sell property if you need funds. That makes real estate best for long-term investments.

Investments in your 401(k) and IRA aren’t completely liquid, either — you can withdraw money before retirement age, but you’ll suffer a tax penalty by doing so.

What is the best way to invest money in the short term?

Choose liquid investments for the short term (in other words, make sure the funds are easily accessible). 

For short-term goals where you expect to withdraw the money within two to three years, you can invest in products like CDs or high-yield savings accounts that pay higher interest than basic savings accounts. 

What you want to avoid is short-term active trading (trying to time the market by quickly buying and selling stock). Most of us aren’t skilled enough to do this effectively. 

How does compound interest impact long-term vs. short-term investments?

Compound interest means that your investment earns interest on the initial contribution, as well as on the interest earned. 

Basically, you earn interest on interest, which has a bigger impact on long-term investments because there are more compounding periods to increase the total value. 

Short-term investments can still earn compound interest, but returns aren’t as dramatic. 

TL;DR

When deciding between short-term versus long-term investments, recognize that both are important for your overall financial plan. 

“Even if you have $10 a month, you should start investing with that $10 a month, rather than think it’s okay to wait two, three years until you have $100 a month to invest,” says Erika. 

Think of short-term investments as more focused savings, where you have a target date in mind for certain funds so you don’t lock them up where you can’t get to them. 

Long-term investments like retirement accounts have many years to grow in value, due to compounding interest. 

Both long-term and short-term investments are a way of practicing delayed gratification. Instead of spending all your money now, invest a decent amount to prepare yourself for the future — both near and far.

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