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When it comes to investing in the stock market, there are lots of opinions out there as to the best methods. Common methods to invest in the stock market are to buy single stocks (stock picking), ETFs, mutual funds, index funds, or any combination of these. This can be stressful for many, which leaves people feeling lost. Whatever method is used, the goal is to find what method works for the investor. People will always ask themselves any combination of “How long should I hold this?” or “When should I sell?” This leads people to either sell and buy using a short-term investment strategy or a long-term investment strategy.
What Is Short-Term Investing?
Short-term investing is when an investor has a near-sighted view of the future and makes investment decisions based on this perspective. Usually, this means the investor is buying and selling stock regularly to try and get the best price and the quickest return within 12 months.
Pros:
- If handled correctly and if you are well-educated, this can lead to large returns quickly
- High liquidity- Ability to sell and reinvest easily to continue to boost returns
Cons:
- This is risky and can also lead to large losses
- Gains are taxed at ordinary income rates
- More likely to mistime the market
- Hard to determine overall costs
What Is Long-Term Investing?
Long-term investing eliminates a lot of the stress associated with investing in the stock market. Once an investor has identified which method they want to use to purchase stocks, then it is a matter of “setting it and forgetting it”. An Investor will keep their investment strategy for a long period, continually buying and holding their investments for 5-50 years.
Pros:
- Less risky than short-term investing
- You pay less in taxes
- Simplifies the compound interest
- Investment costs are determinable
Cons:
- Lower risk generally means a lower reward
- This is usually a less exciting investment strategy
What Is Compounding Interest?
Simply put, compounding interest is the interest earned on the principal amount and all previously earned interest accumulated over time. Here is an example:
If an investor invests $1,000 on Jan 1 at an interest rate of 8% annually, after the first year the investor will have earned $80. In the second year, the investor will earn 8% on the original $1,000 invested and the $80 earned in the first year. This means in the second year the investor will earn $86.40, which is an accumulated interest earned of $166.40. If the investor never invests another dollar and lets the original $1,000 earn an 8% return every year for 30 years, the investor will have $10,062.66 after 30 years.
| Year | Total Invested | Accumulated Interest Earned (8%) | Total |
| 1 | $1,000 | $80 | $1,080 |
| 2 | $1,000 | $166.40 | $1,166.40 |
| 5 | $1,000 | $469.33 | $1,469.33 |
| 10 | $1,000 | $1,158.93 | $2,158.92 |
| 20 | $1,000 | $3,660.96 | $4,660.96 |
| 30 | $1,000 | $9,062.66 | $10,062.66 |
In Summary
Short-term investing is a beneficial strategy to keep high liquidity and to build returns quickly, although there is more risk with this strategy. Long-term investing is beneficial for investors who do not want to deal with the stress of trading regularly and want to have a “set it and forget it” mentality while reducing risk. Although, you should not forget about your investment completely, regularly checking performance and earnings is recommended. Keep in mind that the cost (expense ratios) associated with any investment can greatly decrease your returns. The longer an investor keeps their money invested, the more the returns compound and the larger the return.