Choosing the right investment strategy is no simple task. How can you be sure the investments you’ve chosen are the right ones to get you where you want to be? One of the biggest mistakes an investor can make is not aligning the timeline of their goals with their investment types. This is why investment time horizon is so important.
Investment time horizon refers to the amount of time an investment will be held before the money is needed back. Time horizons drive the type of investment portfolio you assemble. The longer a time horizon, the riskier a portfolio will tend to be. In this context, risk usually refers to exposure to the stock market through individual stocks or equity mutual funds. If the stock market takes a dip, a longer time horizon allows more time for the portfolio to recover.
There are no concrete parameters for investment horizon and duration, but a helpful way to view them would be through three lenses: Short-term, intermediate-term, and long-term.
- Short-term goals are those less than five years away. If markets were to drop, this timeframe could be too short for a portfolio significantly exposed to stocks or equity funds to recover. Because of this, short-term time horizons often utilize cash or cash-like investments. Money market funds, savings accounts, and short-term bond funds are all examples of short-term investment vehicles.
- Medium-term goals are those between five and ten years away. With this much time, some exposure to both stocks and bonds will allow the portfolio to grow without being overexposed to risk.
- Long-term goals are generally more than 10 years in the future. Over such a long time period, heavy exposure to stocks and stock funds offers greater potential return. Even if markets do tumble, the strategy has enough time to weather the storm and continue to grow.
Adjusting your horizon over time is crucial. After all, a goal that is ten years away today will be a lot closer in five years! A common mistake investors might make is sticking with a long-term time horizon investment strategy for too long. Let’s say an investor starts to save for retirement – a goal with a long-term time horizon – with a strategy heavily exposed to the stock market. Over the lifetime of their investment, the market takes several downturns, but due to the long-term timeframe has plenty of time to recover. As the investor nears retirement, they fail to reevaluate and adjust their portfolio to reflect their new time-horizon and the market crashes. With less than a year until their planned retirement day, their nest egg is now worth drastically less than it would be if they have transitioned to a shorter-term vehicle in their portfolio.
An investor’s time horizon is constantly shifting with age, changes in financial situation, new goals, and more. It’s even possible to have multiple time horizons in play at once. Perhaps you are saving for retirement while also saving to pay for your children’s college or buy a new home. Periodically reviewing your goals as well as the time-horizons that accompany them is key to a sound financial strategy.