When you think about your investment time horizon, you should first think about when you will need to access the funds to achieve your financial goals.
Whats considered a short-term goal for one person may be a mid- to long-term goal for another person, depending on factors like their age and personal risk tolerance. Understanding your time horizon can help you stay on track to meet your financial goals.
What is a time horizon?
A time horizon in investing refers to the length of time you expect to own your investment before youll need to access your funds. Keep in mind, your financial goals and preferred investment strategy may impact your time horizon.
Whether you are saving for education or a vacation, your time horizon really boils down to determining when you need the money. And the time horizon helps you determine how long your dollars will need to be invested and the appropriate investment mix to achieve your desired financial goal, says Nicole Birkett-Brunkhorst, certified financial planner and wealth planner at U.S. Bank Private Wealth Management.
Common time horizons
Investment time horizons can generally be broken down into three categories: short-term, mid-term, and long-term.
Short-term
Generally, if you will need access to your funds within the next few months or years, your time horizon would be considered short-term.
A short-term time horizon needs to be fairly liquid, so consider investing your funds into assets that can be converted to cash, with minimal volatility, such as a money-market account, certificate of deposit with a short maturity, or a high-yield savings account.
For instance, lets say you have a goal to save $2,000 to purchase a new laptop before you enter graduate school in two years. If you began tucking away $82 each month in a money market account that earns 2% interest annually, by the time you enter school, you will have saved a total of $2,006 by saving $1,968 and earning an additional $38 in interest, says Birkett-Brunkhorst.
The goal of a short-term time horizon is to invest conservatively enough to protect your initial investment while still generating some additional income.
Mid-term
A mid-term time horizon generally ranges from five to 10 years, depending on your financial objectives and individual investment preferences.
Mid-term investments tend to be a mix of both conservative and aggressive investments to reduce the risk of total loss to your initial investment. At this point, you may begin mixing in some low-risk bonds and T-bills along with stocks to diversify your portfolio.
Birkett-Brunkhorst gives another example:Lets say you have a goal to purchase a home with at least a $15,000 down payment in the next eight years. If you began investing $125/month in an investment account earning a 6% average annual rate of return, you will have exceeded your goal and saved $15,250 by saving $12,000 and earning $3,250 in returns.
The aim of a mid-term time horizon is to begin generating more income using a slightly riskier investment strategy, while still protecting your initial investment. Its important to note that all investments have some degree of risk, including CDs, bonds, and stocksif the stock market declines, your investment faces the risk of losing value.
Long-term
Any investment goal with a time horizon of 10 years or longer is considered long-term.
With a long-term investment, you generally have the ability to stomach market volatility in the short-run in hope of achieving long-term gains. Initially, you may opt for riskier investments with low liquidity to produce greater returns, then tailor your portfolio later on toward more conservative investment strategies to protect your gains before you need to access them.
For instance, lets say your financial goal is to add an addition to your home so your parents can move in with you when they retire in 15 years. Your contractor has provided you with an estimated cost of $60,000 to build the addition. If you placed $180 of your monthly income to an investment account earning an 8% average annual rate of return by the time your parents retire, you would have a total of $60,770 by investing $32,400 of your own funds and earning $28,370 in returns, says Birkett-Brunkhorst.
Why is it important to know your time horizon?
Understanding your time horizon can help you choose a suitable investment plan to meet your financial goals. You may choose to invest more conservatively to protect your funds or invest in higher-risk assets. Knowing your time horizon helps you gauge whether you have enough time to recover from investment risks if the market declines, says Nicole Horton, certified financial planner and senior private wealth advisor with Wells Fargo Advisors.
For instance, lets say you are saving up for a trip to the Bahamas in two years. Since you know you need to access the funds in the near future, you would avoid putting your funds in a high-risk investment to protect your funds from market volatility. Instead, you might choose to purchase a 52-week T-bill, for example, which can boost your vacation fund at a lower risk.
On the other hand, lets say you want to help your grandchild buy their first car when they turn sixteen. Since you have a longer time horizon, you can begin investing more aggressively purchasing stocks, for example, in the beginning to aim for higher returns and later switch to a slightly more conservative strategy as you near their sixteenth birthday.
With that said, its important to choose an investment strategy that you are comfortable with. If you are a risk-averse investor, you can still choose to invest your savings conservatively over a long-term time horizon. But to achieve your financial goals, you may need to alter how much or how often you invest. Consider speaking with a trusted investment advisor who can help guide you towards the right investment strategy for your risk tolerance level.
How to determine your time horizon
Determining your time horizon starts with figuring out when you will need access to the funds. If youre saving for a specific event, your time horizon will generally fit in one of the three common time frames. From there, you can begin estimating how much money you will need to invest in order to meet your financial goals in alignment with your investment strategy.
The most important thing to remember when determining your time horizon and sticking to it, is to check in on your progress often. Especially when you have multiple investment goals you are saving for concurrently, it can be easy to lose track of your goal which can delay your timeline or reduce the returns you will earn by your goals end date. You should review your investment strategy and time horizon every year, if not more often, says Horton.
The takeaway
Identifying the time horizon on your financial goal can help guide you towards the right investment strategy to meet your needs. Your individual risk tolerance plays a role in determining your time horizon.
In general, longer term investments have the ability to stomach market volatility in hopes of gaining higher returns, whereas shorter term investments should be structured towards more conservative strategies to protect your initial investment.
Your risk tolerance should be tied to not only how long- or short-term your end goal is, but then you should also readjust it as you get closer and closer to your end goal, says Horton.
