Investors are exposed to a variety of risks when expending funds. These financial risks include systematic and unsystematic risks as well as business, sociopolitical, inflation, liquidity, and interest rate risks, among others (Chen, 2022). In addition, investors should make a decision whether to invest their money short- or long-term. Thus, long-term instruments are any investments of over a year, including stocks or bonds, while investments under a year are considered short-term. Unlike short-term instruments, long-term ones are exposed to interest rate and maturity risk due to changing interest rates (Brigham & Houston, 2021). The bond price decreases as the interest rates rise, negatively affecting the overall investment. The sensitivity of a bond price to changes is measured by duration, with greater duration resulting in greater sensitivity (Gallant, 2022). Due to their nature, long-term investments are more likely to suffer fluctuating interest rates than short-term tools and, consequentially, are at more risk (Gallant, 2022). Thus, interest rate risk is higher in long-term instruments.
In addition, it can be argued that liquidity risk is higher for long-term investments. Long-term instruments, such as bonds, cannot be converted to cash needed to meet debt obligations quickly. Such actions may result in a commission, with multiple bond sales depressing the market (Brigham & Houston, 2021). Meanwhile, short-term bonds can be sold due to less default risk (Brigham & Houston, 2021). Similarly, inflation risks are higher for long-term investments as, with a longer investment duration, its returns diminish over time due to rising prices. However, short-term investments are at a higher risk in a volatile market with frequent price fluctuations (Ashford & Schmidt, 2022). If short-term investments can return a loss in an unstable market, long-term investments are likely to endure. Overall, long-term and short-term instruments are exposed to different risks, and investors should carefully consider the potential changes in the market when expending funds.
References
Ashford, K., & Schmidt, J. (2022). What is market volatility—And how should you manage it? Forbes Advisor. Web.
Brigham, E. F., & Houston, J. F. (2021). Fundamentals of financial management: Concise edition (11th ed.). Cengage Learning.
Chen, J. (2022). Risk. Investopedia. Web.
Gallant, C. (2022). Interest rate risk between long-term and short-term bonds. Investopedia. Web.