If you have shown any kind of interest in investing over the years, it is possible that you would have come across the classification of long-term and short-term that investment practitioners group investment products under. Long-term products usually include stocks, equity-focused mutual funds, real estate and annuities. Short-term products on the other hand, include government bonds, fixed deposits, money market mutual funds, treasury bills and savings accounts.

From the examples given you can see that the long-term products mostly have some risk as the returns are uncertain and the inflows are unpredictable. However the short-term investments have mostly fixed, predictable returns. These different characteristics – volatile vs predictable – are often all what people mean when they talk about long-term vs short-term. I think that is totally different from how new investors understand short-term and long-term and in this post I will try to explain why this distinction is not too important and how we can classify investments in more meaningful ways.

To start with, the objective of an investor is to get the highest return possible at the lowest risk possible. Whether the right combination of risk and return comes from investments classified as short-term or long-term is irrelevant. For example, if you were seeking to invest for 10 years and you had to choose between a fixed deposit guaranteeing a return of 20% annually, or a collection of stocks which has returns ranging from -50% to 50% per year, then it would be a rational decision to invest in the fixed deposits even though it is usually classified as short-term. What matters is the risk-return profile of the investment and not the traditional time classification.

A second example could be if you were planning to invest for only a year, and you had the choice between a treasury bill which returned 14% or an equity-biased mutual fund which has returned between 10% and 25% over the past 5 years, then it would make sense to invest in the second option. Because the downside of the mutual fund is not significantly lower than the return of the treasury bill but the upside is much higher.

Another reason why the long-term vs short-term dichotomy is not too important is because the overwhelming majority of investors simply do not have the funds to properly segregate investments between long-term and short-term. Most of them will need the funds they put in investment to pay their rent, pay fees, buy a vehicle, buy property or some other thing. It is only the high net worth individuals who usually have enough funds to take on really long-term investment projects. Unfortunately, most investors’ only true long-term financial investment is their pension contributions. Any other thing is on the table for consumption when challenges show up.

So if long-term and short-term are not definitions that can adequately describe investments, then what descriptions are better? I think more accurate descriptions for investments are liquid vs illiquid or fixed returns vs variable returns. A mixture of these different kinds of investment may be needed in a portfolio. And I will write on finding the right mix in another post.