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.
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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.
Asset allocation and time horizon
Due to the relationship between risk tolerance and time horizon, an investor’s time horizon may impact what types of assets are included in their portfolio.
- Short-term time horizon. Because investments with short-term time horizons won't have as much time to recover should the stock market take a dip, a short-term investment strategy usually has a more conservative investment approach and contains more stable, less risky investments—think cash, or liquid, cash-like assets. With a shorter time horizon, one might find an 80/20 mix, in which 80% is in cash and the remaining 20% is in securities.
- Medium-term time horizon. A medium-term investment strategy needs to do two things at once: protect accumulated investments while also aiming to grow these investments. As a result, a portfolio with a medium-term horizon might include a more balanced mix. For example: Imagine an investor saving for a second home they would like to buy in seven years. They might have a portfolio that is 40% invested in bonds, and 60% invested in stocks. If the investment time horizon were a bit shorter, the portfolio mix might be flipped so that it's more conservative, with 60% in bonds or cash and 40% in stocks.
- Long-term time horizon: A long-term investment strategy can be more aggressive because the investments have more time to ride out any tumbles in the stock market, and short-term losses could turn into long term gains. For example, a portfolio with a long-term time horizon might be 80% invested in stocks—including some growth stocks—with 20% or less in cash.
For investments with any time horizon, as an investor nears their target date for an investing goal, or the end of their investment time horizon, they would shift the portfolio mix toward more conservative investments to minimize risk.
Note: While time horizon and risk tolerance are inherently related, an investor’s overall disposition towards risk is also a factor. Some investors are more comfortable with risk than others, which can influence their portfolio mix.