Time plays a huge part in everyday decisions. Your morning preparations can look very different if your work commute takes an hour versus if you’re only a few minutes away from the office or working from home.
In investing, time also influences how you plan for the journey. Your time horizon helps determine the investments you’ll choose, the strategy you’ll follow, and the amount of risk you’ll take.
What is a time horizon?
Your time horizon is the length of time you expect to hold an investment before withdrawing money. You may hold an investment over a short, medium, or long period.
Types of time horizons
- A short-term horizon lasts less than 3 years. This is for goals you aim to achieve soon, like trips or large purchases.
- A medium-term horizon is 3 to 10 years. It matches bigger milestones like home ownership or starting a family.
- A long-term horizon lasts 10 years or more. Retirement planning and wealth building are the most common long-term goals.
Why does your time horizon matter?
Here’s how your time horizon can influence your investing decisions:
- Managing risk
If you have a short time horizon, it’s generally unwise to accept big risks since you’ll need the money soon. Choosing low-risk investments lessens the possibility of withdrawing at a loss during a market downturn.
On the other hand, a long-term horizon gives you time to weather market ups and downs. Investors who are decades away from a goal can wait out volatility, allowing them to accept higher risk.
- Choosing investments
Your time horizon influences your risk capacity. It’s crucial to consider both when choosing investments for your portfolio.
For short-term goals, it’s ideal to pick lower-risk options like money market funds, short-term bonds, or time deposits. These investments have a relatively low growth potential, but they’re also less likely to see a drop in value.
Long-term investors can hold a larger portion of higher-risk assets if their risk profile allows it. Investment vehicles that carry more risk tend to offer higher potential returns over time.
Investing for medium-term goals involves striking a balance between risk and growth.
When investing in pooled funds, you’ll see a recommended time horizon on the fund fact sheet to guide your decisions.
If you’re considering fixed-income assets like bonds and time deposits, the maturity date/s should align with your time horizon.
- Building your portfolio
Your asset allocation depends on your time horizon and the amount of risk you’re comfortable taking.
For example, growth-focused allocation models – like the popular 70-30 split of stocks and bonds – are often recommended for long-term investors.
However, if your risk tolerance is low, you may want to build a less aggressive portfolio and prioritize safety.
You can also invest for multiple goals with different time horizons. Consider maintaining dedicated portfolios for various goals so you can follow the best approach for each.
