Investing is prone to a lot of external noise and opinion, especially for a new investor. You’ll hear a lot of things like this:
“Why are you still holding that? It’s a short-term play!”
“You shouldn’t allocate there. Look at this stock for long term growth”
The decisions you make in response to these comments are dependent on your orientation as an investor: are you investing for the short-term or are you making investments with a long-term mindset? Both have their advantages and drawbacks, and both can be strategically used to generate returns.
What is the difference?
The relationship between short-term and long-term investing is temporal in nature. It’s all surrounding time.
A short-term investment is one in which you might hold for less than a year, maybe a few days or even hours (if you’re a day trader). Most traders use short-term investments to profit from stock volatility, quick expected gains, or optimistic earnings announcements. Whilst any investment can be short-term, the best investments will typically be volatile to ensure there is an opportunity to “buy lower and sell higher” and will have high liquidity, so investors can enter and exit positions quickly. In terms of stocks, short-term plays are usually ones with small to medium capitalisation in high-growth industries like technology, which exhibits strong price movements.
Long-term investments are characterised as assets you will hold for longer than a year, sometimes 10, or 20 years. The most common long-term investment for you will likely be your house. It is a significant purchase for every individual, and the average Australian holds it for 7.5 years. Like short-term investments, any investment can be long-term. However, common long-term assets are those which are defensive, grow slowly and predictably, and can be illiquid. Long-term stock picks are often large capitalisation companies and household names with high social visibility and a strong customer base. Think the big banks, consumer staples, or large domestic insurers.
Outside of stocks, what assets could I select?
Bonds: Regarded as a ‘fixed income’ instrument, they represent a loan made by an investor to the bond issuer, that sees the investor lend a determined fund amount in exchange for regular coupon payments and full repayment of the principal amount. Bonds with a duration longer than 1 year, such as a “5-year Australian government bond” represent a safe, long-term investment with forecastable returns.
ETF: Exchange-traded funds aim to track an asset class/basket of assets, mirroring an index like the ASX200. Depending on what index or asset they track, ETFs are suitable long-term assets because they can represent stable and healthy growth and are easily tradable through increasing liquidity within the share market.
Real Estate: COVID-19 has shown how strong the domestic property market is. House prices are up 19% across the major capital cities over the past year and since last September, the median house price has risen $240,000. Despite requiring high levels of capital to invest, they are perennial defensive assets great for long-term investing.
Forex Trading: Trading currencies and currency pairs like the AUD/USD are largely employed by traders as a tool to generate returns given their high levels of volatility and easy entry, expressed through ample liquidity. Traders will use technical analysis and fluctuations in interest rate differentials, built upon central bank decisions, to make a profit. Cryptocurrencies, due to their increasing accessibility, are also being used as profitable short-term investments by investors and retail market participants.
Commodities: Represent a suitable short-term investment due to high price volatility, catalysed by geopolitical changes, general economic conditions, and demand and supply fluctuations. Precious metals specifically, also have the added benefit of protection against inflation, which can erode the real purchasing power of returns.
When to choose the long-term over the short-term
You have time on your side
Young investors, and those new to investing in the market, should opt for longer-term investments as they are better at safely growing invested capital over a longer time horizon if you’re not in a rush. Longer investment durations also allow for capital to recover to a greater extent from market fluctuations, like the COVID-19 pandemic. Thus, you have more time and flexibility to learn about the market, gain investing experience, and better manage future investments. ETF’s or super fund allocation are common tools young people use to establish funds for retirement.
You are risk averse
Long-term value investing prioritises careful stock selection to minimise downside risk and maximise possible returns. Long-term investing thus can take time, in the investing process, but also in waiting for your research to materialise into higher equity prices. The benefit of this compared to short-term investing is that there is inherently less risk involved. This approach may thus appeal to investors who value risk avoidance and already employ investment techniques like security diversification to optimise portfolio performance.
You have upcoming expenditure needs
Short-term investments are optimal for investors who may require their returns for short-term needs, such as to fund car repairs or to allocate to family purchases. This is because of the liquidity edge short-term investments have. At any set price, an investor will be able to exit their cryptocurrency positions and reap the gains made.
You are risk seeking
Risk-seeking investors will often prioritise growth stocks as a short-term play due to their ability to outperform value stock returns, with a stronger risk profile. Growth stocks exhibit higher volatility and more violent price swings, but the endurance of such can lead to significant outperformance of the market, which is attractive for those with higher risk appetites.
Why long-term investing works best
Long-term investing has been proven to deliver returns. Even if you just invest in the market (the market portfolio), it will generate safe returns that still will outperform the returns one may receive by leaving cash in the bank.
Credit Suisse research suggests that in 2019, Australian shares have given their investors an average annual return of approximately 6.7% per year since 1900. Accordingly, this makes the ASX the second-best performing share market over this time horizon. Our post-COVID bounce back also reflects ASX resilience – 12 months after a pandemic it hit record highs.
Recall that this type of investing is also lower risk, with lower exposure to volatile price movements.
Lower fees and costs
Too many investors forget about transaction costs. Remember that every trade you make costs money. It’s the price you pay for investing in company shares. This takes money from your back pocket and reduces the amount you could be investing.
Lower transaction fees are thus a key advantage of long-term investing, leading to higher returns. Because transaction fees are induced through buy and sell orders, buying a share once and holding it for a long period of time protects you from these costs. Short-term investors must factor regular market costs into their final returns.
Long-term investing can also help in Capital Gains Tax outcomes. Critical to investing is preserving your hard-earned returns on stocks you took the time to select. Constant buying and selling position your returns vulnerable to your marginal tax rate, which can exceed 45%! Holding your shares for longer than 12 months can allow you to benefit from some tax concessions.
Short-term investing relies on accurate prediction of future conditions to maximise returns. But given the COVID-19 pandemic and increased globalisation, international financial markets are more closely linked, and it is thus becoming more difficult to make these accurate predictions.
Investing in shares with a long-term mindset ensures time is on your side. The longer you invest, the greater chance your shares outperform other assets, and the lower risk you face of negative returns.
Cutting out emotion
It is commonplace to place “fear” and “greed” as the two dominant emotions in investing. As humans, we all inherently exhibit both, but too much of either adversely impacts our investing outcomes. Overly fearful investing prevents us from taking logical risks, where excessive greed contributes to significant losses.
Setting your investment horizon as long-term allows you to maintain a rational investing mindset, that separates you from damaging fear and greed emotions. The prioritisation of short-term gain can often see individuals deviate from their well-considered investment thesis and make rash decisions based on the opinions of others.
Warren Buffet is one of the world’s strongest advocates for a long-term approach. He says
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”.