Your investment horizon could be the most crucial thing to your investment success
“Where are you going to be in five years’ time?” is a question you might hear in a job interview, goal-setting workshops, or even on a date.
Why? Whoever is asking you the question is really asking about your plan. Because to succeed at anything, you need to think ahead and have a plan. This applies when it comes to your career, your physical health, business, your relationship, and, of course, your investments. The very reason you invest is the future, after all!
Investment Horizon and Planning
Even though you know the world is an uncertain place, planning is still critical. While some things are in your control, many are not. This shouldn’t stop you from having a plan. If you identify the factors of success, put targets in place, and stick to them, you’re more likely to succeed.
A successful plan will accept what is unknowable and build resilience into the plan itself. This ensures that minor setbacks do not disrupt the entire plan and, at the same time, enables you to seize opportunities that may arise along the way.
What Is a Time Horizon?
The first question you need to consider with any investment is:
When will you need your money back?
Time horizon describes the answer to this question: the amount of time that passes before you need to access the money that’s tied up in an investment. In other words, the time horizon is the expected time available to hold an investment or to achieve a financial goal.
If you are building up a stash for a particular goal –retirement, a house deposit, a rental property, or even short-term goals such as a holiday – you almost certainly have a timeframe in mind. There are a couple of clarifications with this:
Even if you’re investing to build passive income, you still probably have a rough timeframe in mind of when you hope to achieve a certain level of passive income, perhaps to fund an early retirement.
If you’re saving for retirement, then you’ll only start drawing down from some of your investments when you retire. In other words, retirement isn’t a one-off event when you’ll simply cash in all your investments on day one of retirement and keep the proceeds in the bank. Instead, it’s much more likely you’ll still need at least some investments to last many decades into the future – especially with life expectancy becoming longer.
Why Time Horizon Is Critical for Investor Success
Understanding your time horizon is one of the most critical factors that determines how you invest your money in the first place. In fact, the two things that separate successful investors from losers are most often:
A long investment horizon
Once you can identify a realistic time horizon for the goal you’re investing toward, you can think about your investment plan in more detail. Understanding the difference between short- and long-term investments is important because some investments will support goals of different timeframes better than others.
Time Horizon and Risk Tolerance
Deciding the timeframe of your investment horizon can help inform (or influence) your risk tolerance as an investor. Your tolerance for risk is, as it sounds, how much investment risk you can tolerate, when risk equates to the risk of losing money. If you can’t sleep unless you know your investment assets are relatively secure, and you’re on edge when investment markets are bumpy, you probably have a low risk tolerance.
Investors who have a low-risk tolerance are considered risk averse, and they may prefer more conservative investments, like bonds. Low-risk investments like bonds and term deposits are less volatile, but they typically also have lower returns than higher-risk investments like stocks (shares) and real estate.
Even if you’re an aggressive investor when it comes to your risk tolerance, if you are saving for a deposit on a home and have a short time horizon of a year or two, you still may choose lower-risk investments like term deposits and bank savings accounts for such a short investment horizon. That’s because your time horizon has taken precedence over your appetite for risk – you’re unlikely to accept the volatility that comes with other investment types. If you were to invest in volatile assets over this timeframe, a routine drop in investment values could mean you cannot buy a home when you intended, as your deposit may not be large enough.
But, let’s say you have a low risk tolerance, but you have a lengthy time horizon to save for retirement - say 20 or 30 years. With a time horizon of two or three decades, your portfolio has more time to recover from periods of volatility. Therefore, you might feel more comfortable having a higher percentage of stocks (shares) in your portfolio. Even though that increases your risk to some degree, it also increases your potential for growth over time.
This concept is often referred to as the risk-reward ratio, or a risk-reward calculation. Since no investment is genuinely risk-free, using a risk-reward ratio helps calculate the potential outcomes of any investment decision — good or bad.
Investment Horizon Flexibility
None of us can predict the future.
Things are always going to happen that will impact our time frame. What matters is how comfortable you are adapting to the change and being flexible on when you need to access your money.
The Bottom Line: Your Investment Horizon
Determining your investment time horizon is the critical first step of investing.
Get in touch to discuss your situation and explore what investment opportunities might suit your unique circumstances.
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