An investment time horizon helps investors understand how much time they feasibly have to reach their financial goals. This can help an investor assess how much time they have before they need to sell an investment, as well as how much risk they can bear. In turn, this information will help determine the mix of investments in their portfolio.
What is an investment time horizon?
Technically, an investment time horizon is the amount of time you need to hold onto an investment before you sell it. It's typically linked to the amount of time you need to reach a financial goal. It could be a number of months, years, or decades. Imagine a 35-year-old investor saving for retirement, with the goal of retiring at age 65. In this case, their investment time horizon would be 30 years.
Factors that influence time horizon
Each individual’s time horizon is different. The following factors inform an investor’s time horizon.
- Target date for goals. An investor’s time horizon largely hinges on how much time they have to reach their financial goals. For instance, if someone plans to send their child to college, and their child is set to start college in 2030, the investor would have a time horizon of 9 years if they start investing in 2021.
- Age. For long-term goals tacked to major life milestones, age can play a big factor. For example, someone who begins investing at age 25 and would like to retire by 65 would have an investment time horizon of 40 years. If they are 35 and would like to leave the workforce by 70, they have 35 years to build that investment income for their golden years.
3 types of investment time horizons
Put simply there are short-term, medium-term, and long-term investment time horizons.
- A short-term time horizon applies to financial goals an investor wants to reach in five years or less, such as buying a car.
- A medium-term time horizon generally applies to financial goals with a timeframe of five to 10 years, such as a down payment on a house.
- A long-term investment time horizon usually applies to financial goals at least 10 years away, like saving for retirement or sending kids to college.
Investment horizon and risk
An investor’s time horizon is inherently tied to risk. When an investor has less time to reach a financial goal, they won't have as much time to recoup any potential losses. However, if they have more time to reach a financial goal, they may be more likely to withstand any potential dips in the market. Therefore, shorter time horizons have a lower tolerance for risk, while longer investment time horizons have a higher tolerance for risk.
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