One of my school friends has always been enthralled by the dynamics of the stock market. She always had a desire to try her luck in investment, but lack of knowledge pulled her back, from doing so.
I am pretty sure most of the readers have a similar story!
People are clueless about how to start and where to end. And, the most basic question which arises in their mind is usually related to types of investment, the difference between them as well as which type of investment would ultimately suit their needs.
Well, the following content will answer all your queries and confusion.
Before addressing the elephant in the room, (the difference between long term and short term investment), let’s get started with some basic definitions.
Most of you must have guessed about what long term investment, just by the usage of the word- the ‘long term’. You might have guessed that the investment which an investor holds on for a longer period of time is a long term investment.
This is not a wrong explanation but, a crisp and precise version of this definition is mentioned as follows-
The investment plan which would provide you with better and higher returns over a period of 10 years, as compared to other competitors is called a Long Term Investment. They have a higher probability to provide you with higher returns.
Practically speaking, there is no sure shot formula to predict which type of investment would give you better returns over a longer span of time, but after analyzing past records we can surely get down to some useful data.
Generally, investments made in stocks, bonds, real estate and cash are categorized as the best long term investment.
If on one hand, long term investments are known to provide a better return, then, on the other hand, you need to be patient in order to gain profit in long term investment.
Remember, the keyword to keep in mind while investing for the long term is patience.
You can’t afford to panic in long- term investment even when the market is down!
Let us try to understand how the term investment works with the help of an easy-breezy example- Consider a hypothetical situation where a person by the name Rohit decided to buy a piece of land, which is roughly 400 acres. He bought that piece of land in order to build a shopping complex. He reserved 250 acres for the shopping complex, 50 acres for luggage keeping store and parking space as well.
Further, he decided to keep the leftover land which was approximately 100 acres. He decides to hold that piece of land, with the aim to secure it as an investment. He wanted to sell it to any manufacturer who would require it for expanding his/her business.
Now, this 100 acres of land which Rohit decided to hold on to, is classified as a long term investment.
Renounced investors from all around the world, often support and follow long term investment. A great example which can be quoted here is of Mr Warren Buffett who invested in Coca Cola back in 1988 and he still holds shares in that company.
Just like long term investment, the phrase 'short term' sprouts your basic concept about short term investment.
In financial language, short term investments are those types of investments that you decide to hold for 3 years or less than that. The time period for which you decide to hold on to short term investment is less and you tend to get comparatively sooner returns.
But, one of the most crucial points which you need to keep in mind while making a short term investment is to have a brave heart.
Yes! You should be ready to accept the amount of risk associated with the short term investment. This is a well- known fact that the potential risk associated with all short term investment is relatively high. The main reason behind this is the fluctuations that occur at higher rates in the case of short term investment.
Several types of short term investment include- stocks, mutual funds, some bonds, money-market accounts, treasury bills.
Example of short term investment- Apple Inc. held short term investment under the category of marketable securities, in 2018. It amounted to roughly ₹18.05 lakh crore. Whereas, the short term investment held by Microsoft Corp. for the same years was approximately ₹7.66 lakh crore.
I am sure, by this point, you all must have understood the basic meaning of these two types of investments, and that they differ from each other on a large scale.
Let us now dwell upon the differences between these types of investment-
Short term investments often lure people due to the quick return but the risk associated with them is also potentially high as compared to long term investment.
Thus, if you invest in the stock market (which is a type of short term investment), there is a good chance that you might win a handsome amount of money with it, while you could also end up losing every hard-earned penny of yours.
On comparing both short and long term investment, you will surely come to the conclusion that long term investment tends to provide more stability to the investor as compared to short term investment.
This is due to the reason that long term investments take their own sweet time to mature and their steady pace is what radiates them stability.
On the other hand, because of the high rates of fluctuation, the degree of stability provided by the short term investment is relatively low.
Let us move on to an analysis of the maturity time and the amount which investors gain after it. This is a known fact that long term investments take more time to mature, and the growth rate is steady too. It attributes the main reason as to why you would gain a small amount of profit or money over a long period of time. You can expect to gain small returns with long term investments.
While in the case of the short term investment, there are full chances that you can gain a huge amount of money in a short period of time. For example, a sudden hike in the market may lead to the sale of stocks at high rates and fill your pockets with loads of money in a single go. Some of the short term investments have a success ratio of 1:1.
But, this goes without saying that people usually make long term investments when they have an ample amount of time into consideration. Long term investments grow continuously over the years and mature as and when you need them.
INCOME TAX ACT, SECTION 10(38) [For long term investment]:
This particular section from Income Tax Act 1961, guides Indian citizens regarding the gains they obtain while making long term investments.
As an investor, you will receive this gain when you decide to transfer or sell securities that are excluded from taxation.
There are certain pre-requisite conditions for assets to be tax immune, they are mentioned as below-
If and when you invest the assets in equity or share of a particular company.
Investments made in those mutual fund companies that are listed under the stock exchange of India.
In a nutshell, you can get exonerated from tax when you derive gain from those equities that are held for at least 12 months or more with you.
SECTION IIIA FROM INCOME TAX ACT [For short term investment]:
This particular section from the Income Tax Act, states the amount of tax that you need to pay on the net profit you make in short term investment, during a particular frame of time.
Legally, you need to pay 15% tax on the net profit which you reap from a short term investment, of a particular time. If you could not understand how this act would work then, the following example will surely help you to fully grasp its functionality.
Consider a hypothetical situation where you decide to carry out 10 trades (all of them were for the short term). Out of these 10 trades, you incurred a profit of Rs 5000 in 5 trades, while you incurred a loss of Rs 5000 in the other 5 trades.
Due to this, the net profit gained by you throughout those 10 trades, in that period of time is Rs 1000.
Now, as per Section III-A from the Income Tax Act, you need to pay 15% tax on the net profit. And, the net profit in the above case is ₹1,000. The mathematical calculation looks something like this-
Net profit = Rs 1000
Tax percentage = 15%
The tax you need to pay= 15/100 X 1000 => Rs 150
In case of long term investment initially, you need to pay all the required fees and then relax back till the investment matures. While, in case of short term investment the trading takes place on a regular basis, therefore you need to pay the above-mentioned fees quite often.
Your concepts will surely get clear with the help of an example. Consider a hypothetical situation where you decided to buy stocks worth ₹40,000. You had to spend a fee of ₹350 while buying it and then again fees of ₹350 while selling it. This implies that approximately 2% of your investment was eaten by the fees. Thus, you need a hike of 2% in the stocks, in order to go even.
So, short term investment comes with this term, while long term investment tends to fix this problem by minimizing the fees one needs to pay while trading.
Why would anyone choose to make an investment of any kind? There is always some well-thought purpose or need behind taking this decision. Popular investors from all around the world, do all their investment for a purpose and well-evaluated reasons.
Most people make a long term investment with the purpose of building various resources for the time of their retirement. Mostly, they choose to invest for the long term in order to secure their lives after retirement, to leave behind some kind of legacy or in order to pay for the higher education of their kids.
While the purpose behind making any kind of short term investment is entirely different from long term investment. It mostly varies from person to person and their needs. For example, you may make a short term investment for paying the down payment of your house, to plan a family trip or holiday, or to purchase a vehicle. This is primarily due to the reason that you are not tied up for a longer period of time and you can get your money as and when you need it.
I hope by now you all must be thoroughly acquainted with the definition of long term and short term investment as well as the points of major differences between them. Let us now ponder over the main question- ‘which type of investment is better or ideal?’
In my opinion, despite sticking to just one type of investment it is ameliorating to find a fine equilibrium between these two investment options!
The most important point to remember when it comes to investing is that you must keep yourself sorted as far as your objectives and investment needs are concerned.
If you are just starting out in your career and you want to make an investment, then at such a young age it is better to opt for a mix of both long term investment and short term investments. At this stage of your life, you can even handle the risks and fluctuations of the market, in a better way. Having a mixture of investments helps you to understand the intricacies of the market in a more precise manner and ultimately helps you to sharpen your investment skills.
At times you might find short term investment alluring because your money is not tied up for a longer period of time. You are also able to capitalize your money, if and when you get opportunities to do so. These opportunities may arise due to sudden change in the market, change in any economic or political scenario of the country, so on and so forth.
But, it is always recommended to keep aside some amount of your money for long term investment too. Owing to less associated risk, it is the money you invest for the long term which tends to provide security even when the market is at a wreck or in case you make a wrong choice while investing.
If you are a beginner, then you must consider hiring a financial consultant who can assist you while deciding the investment goals, and ultimately help you with the development of a good investment portfolio.
Secondly, always remember to distribute your investments wisely. You should try to invest in a variety of fields available in the market.
“Being a value investor means you look at the downside before looking at the upside.”