One straightforward way to look at the question of an investment time horizon is: when do I need this money? Another way to posit the question is: how long do I expect to hold this investment? The response could be the same or different. In fact, the answer may be different every time you ask yourself the question, depending on the goal you are pursuing, the age when you ask it, and the circumstances at that moment in time. Your portfolio will likely contain investments with various time horizons from short to long.
How Does the Investment Time Horizon Affect Your Investment Decision-Making?
The time horizon will probably affect the amount of risk you are willing to accept—your risk appetite. As an investor, you may be willing to take more risks to seek more rewards. All investments carry some risks, and those with a higher potential premium usually also involve a higher degree of risk. The U.S. Securities and Exchange Commission cautions that investors should understand the possibility of losing some or all of the money they invest in securities.
However, traditional wisdom tells you that the risk is necessary to gain the reward, and since stocks are cyclical, you are wise to take a chance as long as your investment time horizon is adequate. For example, suppose you are an investor in your early working years, constructing a retirement portfolio to build over the next thirty or forty years as you work toward retirement. The standard approach indicates that you have a long investment time horizon and that, as a result, the focus should be on higher-risk investments that will be more likely to earn income and grow but could lose value as well. If losses happen, the theory is that this investor has time to recoup the losses. If history is even close to accurate, the more aggressive course will pay off over the long term than a risk-averse, conservative strategy.
When Is a Short Investment Horizon Appropriate?
Suppose you are saving money for your wedding and honeymoon next year. Perhaps you have most of the funds, but you would like to add to the cushion before you start paying the deposits. You don't need to increase the amount much, but if you incur a significant loss in the next six months, that will pose a problem for your plans. This specific fund is a good candidate for a conservative investment since it has a short time horizon and modest goals.
The Horizon Timeline Can Change.
Of course, plans change, and people age. The wedding may get postponed, or the dream honeymoon fund turns into a house down payment. Inevitably, the time until retirement gets shorter, and the wisdom of aggressive investing may seem less so. Some retirement accounts have built-in shifts for the composition of the risk level, but investors managing their own funds should carefully review holdings of all types. It's crucial to ensure that your retirement plans or other long- and short-term goals aren't derailed by neglecting the investment time horizon.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
