Why You Need to Keep Your Eye on the Time Horizon

If you have ever opened an investment account with an advisor or personal banker, they always ask you about your investment time horizon. It is part of the “know your client” information they are required to collect. But whether you deal with an investment advisor or invest on your own, understanding your time horizon is key to making good investment decisions.

What is your time horizon?

Your investment time horizon is the period of time you expect to hold an investment. Or, put another way, it’s how long you can stay invested before you need the cash. Everyone’s time horizon is different, depending on their investment objectives, available funds, familiarity with investing, career stage, family situation, and a range of other factors.

For example, for day traders, “long-term” might be three days; for someone saving for retirement, “long-term” might be thirty years. Similarly, “short-term” could be anything from a few seconds to a year or more.

Knowing your time horizon for a particular asset is one of the factors that can help you decide how much investment risk you can tolerate. (Another is how you feel and react when you see sharp swings in the value of your portfolio.)

For instance, if your time horizon is 30 years, you can probably tolerate investing more in the stock market. That’s because stock market volatility – that is, the swings in stock prices over time – tends to be less of an issue the longer the time period. You have more time for your portfolio to recover from fluctuations in the stock market.

On the other hand, if you want to put money aside to buy a car in three months, you probably don’t want to invest those funds in the stock market. This shorter time horizon means there is less time for your investments to recover from a bad spell in the stock market. So, in this case, it would be better to stick with a less volatile investment or just a savings account.

Your time horizon is not static

Your time horizon will change over time, too. As you get closer to your investment goal, your time horizon gets shorter and shorter. This shorter time horizon will affect your investment mix.

For instance, if you’re 60 years old, and you plan on retiring at 65, there are only 5 years left until you will need to start generating income from your retirement account. So, your retirement portfolio, or a portion of it, really now only has a 5-year time horizon. This shorter time frame means you might want to have a higher proportion of less-risky assets. This could involve selling some of your riskier investments and buy more conservative, income-generating assets.

But if you’re only 30 years old and are just starting to save for retirement, this long time horizon says you can take on more risk. That means you can own more stocks if you won’t lose any sleep worrying about stock prices.

You can have more than the one-time horizon

You can also have different “buckets” of money that each have their own time horizon. There might be the short-term savings “bucket” that will be used for a trip to the Maldives or a new car. There might be the medium-term “bucket” if you plan on buying a new house or getting extensive plastic surgery down the road. And you might have a long-term “bucket” for the university for the kids or other long-term goals.

Each bucket could then be invested in different ways. The short-term fund would be more conservative – like even just a savings account at the bank (as long as bank fees don’t eat away at your savings). The medium-term money could be invested in a more balanced way, perhaps with some money in stocks, some in bonds, some in cash. And the long-term bucket could be invested more aggressively.

To be a smart investor you have to understand your time horizon. This will help you make more informed investment decisions and will reduce the uncertainty of managing your money.