Why time horizon matters when investing - Part 1

When deciding on what type or types of investments you should hold there are very few questions that are more important than, “What is your time horizon?” The time horizon or investment horizon is the length of time an investor expects to own their investment. If you can estimate the length of time, you think it will take to reach your financial goal, then you will have an idea of what your time horizon is. This will determine the amount of risk you can take and the amount of volatility you can tolerate, therefore guiding your investment selection- what is appropriate, what to avoid and how long to hold your investment before selling.

Good investments for short time horizons

Having a short time horizon means that you will need the money you invest in the near future. As a rule, short term goals are those less than 5 years. Examples include saving for a car, vacation, or the down payment on a home. If your time horizon is short, it means that you have a couple things working against you. First, you do not have much time to make your money grow. Second, if a drop in the market occurs, the date on which the money will be needed will be too close for the portfolio to have enough time to recover the losses.

As a result, it usually makes sense to invest conservatively if you have a short time horizon. Invest in lower-risk investments that are easy to turn into cash such as repurchase agreements or promissory notes. Other investments like short-term bonds can be a prudent move, but in general, you will want to avoid stocks. Betting on a positive stock market move in any given year is a gamble that you typically should not make with money you absolutely need and cannot afford to lose.

Investing for the medium to long haul

Your time horizon would be defined as medium term, if the goal you are investing towards is 5 to 10 years in the future, such as saving for your children’s college education or purchasing a second home.

If you know you have many years before you will need the cash, for example when investing for retirement, you have a long-time horizon- typically defined as more than 10 years. With time on your side, you can take more risk with the peace of mind that if you have losses, you have time to make them up. You can even take advantage of short-term market downturns to invest more at cheaper prices.

Mutual funds that are invested in a balanced mix of bonds (and possibly a little equity exposure) are suitable for both medium- and long-term investors. However, if you have a long-time horizon the most suitable investments are stocks and other higher-risk assets since the potential for growth becomes more important than the need for capital preservation when you have more time to play with. The volatility that those asset classes suffer over shorter periods of time tends to smooth out and leave investors with higher total returns in the long haul.

In conclusion, determining your time horizon is one of the crucial first steps an investor should take when creating a portfolio. It can help you plan better and improve the likelihood of investment success. Pay keen attention to whether you advisor asks you about your time horizon or goals, as this is an indication that they know what they are doing and will help you to choose an appropriate investment.

Look out for Part 2 of this article where I will be discussing the need to change your investment strategy as your time horizon reduces.

Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm

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