Your time horizon is a crucial element of your investing plan. By understanding your time horizon you can select the most suitable investments to help you achieve your financial goals. Read on to discover what a time horizon is, why it matters and how to determine your time horizon.
What is a Time Horizon?
A time horizon is how long an investor plans to hold a security. Time horizons range from a few days to decades. For instance, someone who is just starting their career may plan to hold the investments in their 401(k) for decades, while an investment firm may only plan to hold a security for a few days. Some investment strategies have time horizons that may only last hours or even minutes.
A time horizon is one of the key elements in picking a specific security, overall asset allocation and risk level. One of the first steps in determining an investor’s portfolio allocation is to determine their time horizon. Typically, those who invest in short-term investments don’t want to take on as much risk. While those who have longer time horizons may be willing to take on more risk.
Why Time Horizons Matter in Investing
Failing to match one’s investments with one’s time horizon can mean failing to achieve whatever goal one had in mind when investing. When investors have longer time horizons, they generally take on more risk. This is because the extended amount of time allows the market to recover from a downturn.
For instance, if an investor has a time horizon of 35 years, their portfolio is likely to include more equities than bonds. Some of these equities can include riskier securities such as mid-cap and small-cap stocks and alternative investments. These securities tend to display much more volatility over short periods than large-cap stocks. This is because mid-cap and small-cap stocks tend to be less established and are potentially more vulnerable to outside economic factors.
Most investors adjust their portfolio as their time horizon shortens. For example, when investors approach retirement, they may choose to hold more cash and fixed-income securities and fewer equities to minimize their risk exposure. Fixed-income assets tend to minimize risk because they yield lower returns over longer periods but have less volatility and fewer swings in prices, which provides more stability for the portfolio.
How to Determine Your Time Horizon
Fortunately, for investors, selecting a time horizon is pretty cut-and-dried. For instance, if you have a large payment due within 24 months and want to invest to help cover some of the cost of the payment, you should select a time horizon of 24 months.
Typically, investors don’t have specific time frames like the one in the example above. They generally aim to amass wealth or plan for retirement. These goals may help them meet some of their financial milestones along the way. However, using this method to select a time horizon can be a tad complex for investors. Therefore, it’s wise to clearly map out your time horizons so you can ensure your money is available when you need it.
Investors should always have an idea of their time horizon when managing their portfolio. Once they have an idea, they can then design an outline of their financial plan with a variety of time horizons and investments to coincide with each path. The underlying structure of an investment usually determines what time horizon would be best suited for this asset. By cutting the time frame of an asset short or increasing its longevity, it may rob the investor of maximizing their returns.
Age is the most obvious tool for determining your time horizon. While your age doesn’t necessarily help you qualify for or disqualify you from an investment, it can help you assess how long to hold an investment and which investments that are most suitable. Your age allows you to outline future investment opportunities and determine your financial objectives.
Using your age can help you determine the entire picture of your investing life. To do this, start by placing your age at one end of a timeline and the target age of your big financial goal at the other, such as retirement. This will help you figure out your longest time horizon. From there, you can begin to fill in other financial goals you would like to achieve that need other time horizons.
Even though investors have a wide range of financial goals, here are some financial milestones you may want to include in your time horizons:
- Repaying your student loans
- Making a down payment on a home
- Paying for a wedding
- Buying a new car
- Paying for your children’s tuition
Now that you’re armed with a blueprint of your financial goals, decide how you will reach these goals. You need to consider your initial investments as well as regular contributions that will help you compound the principal amount. If your financial objectives are the destination, your continual contributions are part of the path that helps you get there. The amount you contribute can help you either speed up or slow down the time that it takes you to achieve your goals.
Another consideration is your lifestyle and how you choose to spend your money. Controlling your expenses and spending habits can have a substantial impact on achieving your financial goals. For instance, if you only contribute $100 to your retirement savings but want to retire early, you may struggle to reach this objective in such a short timeframe with your limited contributions.
There is a vast array of time horizons investors can choose from. When selecting your own time horizon, consider your age, financial goals, risk tolerance, income and lifestyle. Each type of investment offers a different level of risk and reward. Investors should consider each type of investment before determining an asset allocation that aligns with their goals.
- Consider talking to a financial advisor about a suitable time horizon to coincide with your financial objectives. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free financial advisor matching service matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- If you have gauged your time horizon correctly and realized solid returns on your investment, you may owe the capital gains tax. Figure out how much you’ll pay when you sell your stocks with our capital gains tax calculator.
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