The Difference Between Long-Term and Short-Term Trading: A Comprehensive Guide

When it comes to investing, there are two main strategies: long-term and short-term. While both involve buying and selling assets, the duration of the investment and the tax implications vary greatly. In this article, we'll explore the differences between long-term and short-term trading, as well as the risks associated with each. Short-term investments are those that are held for a period of time ranging from a few hours to a few months. Intraday traders, for example, buy and sell stocks within a single day.

On the other hand, long-term investments are those that are held for a period of time ranging from one year to several years. 401(k) plans, for example, are considered long-term investments. When you sell a capital asset for a price higher than its original purchase price, the result is a capital gain. Capital assets include stocks, bonds, precious metals, jewelry, and real estate. The capital gain tax you'll pay depends on how long you held the asset before selling it.

Capital gains are classified as long-term or short-term and are taxed accordingly. Short-term capital gains are profits earned from the sale of assets that have been held for less than a year. If you had held the shares for a year or less (and therefore made a short-term capital gain), your profits would have been taxed at the ordinary income tax rate. On the other hand, long-term capital gains are derived from assets that are held for more than a year before they are sold. One of the main risks to which long-term investors are exposed is volatility or fluctuations in financial markets, which can lead to a decrease in the value of investments. The tax brackets for short-term capital gains and ordinary taxable income are also the same, while income from short-term investments is usually added to total taxable income.

The Benefits of Long-Term Investing

As mentioned before, long-term investments are vehicles that one expects to benefit from having for several years.

Long-term investors aspire to hold investment vehicles, such as stocks, bonds or derivative contracts, for several years. This allows them to benefit from compounding returns over time and take advantage of lower taxes on long-term capital gains.

The Risks of Short-Term Investing

On the other hand, short-term investors face purchasing power risk or the risk associated with inflation. This means that their money may not be able to buy as much in the future as it does today due to rising prices. Additionally, short-term investors may be subject to higher taxes on their profits.

Making Smart Investment Decisions

Before selling an asset, you should consider whether the one-year threshold is approaching, as these could be converted to long-term capital gains.

This means that your investments will remain tied up for at least a year, and you won't be able to withdraw money without incurring short-term capital gains if you make a profit. It's possible to get a higher return by charging your investments frequently and repeatedly devoting funds to new investment opportunities. However, that higher return may not offset the increase in short-term capital gains tax bills.