There is one more important way to compare and assess investments, and that is time horizon. The time horizon of an investment is how long you leave your money tied up in the investment before it pays off. For some investments, it’s flexible—you should ideally leave it there for a certain amount of time, but you don’t have to. For others, your money will be completely inaccessible for the duration.
You also have a time horizon for each of your investment goals. For instance, your retirement investing starts out with a long time horizon, whereas if you’re investing for a purchase in a few years, that’s a shorter time horizon. Whether short or long, time horizon is an important consideration in your investment decisions.
Your Personal Time Horizon
When you start investing, one of the most important things to know is when you plan to take the money out. Your investing strategy will change dramatically depending on this factor. For instance, if you are saving for a new home, you might have a time horizon of five or ten years. If investments are going to take longer than that to pay off, you won’t choose these. But if you invest to retire in thirty years, you have plenty of time to pursue all kinds of investments.
Your emergency fund has a time horizon of basically zero—if you need it at all, you’ll need it immediately. So investments like five-year certificates of deposit would be a bad choice. In this case, you’d want a high-yield savings account or similar.
Time horizon affects how much risk you can accept. When you need the money soon, you can’t afford much risk. What if there’s a market downturn and you lose it all? But when you invest for a long time, it’s safe to assume any downturns will correct and any balanced portfolio will see gains. Meanwhile it’s less safe to stick with low-return investments like savings accounts, because with that much time elapsing, inflation will eat away the value of your money. This is why advisors tend to recommend a larger proportion of higher-risk vehicles, like stocks, when you have a long time horizon. Once you’re close to your goal, they’ll suggest moving more of your money into stable products like bonds.
Short, Medium, and Long Time Horizons
So which investments fit into each category?
Investments for a Short Time Horizon
- High-yield savings accounts
- Money market accounts
- Six-month certificates of deposit
Investments for a Medium Time Horizon
- Certificates of deposit
- Bonds
- A minority of stocks
Investments for a Long Time Horizon
- A large proportion of stocks
- A small proportion of bonds
- Real estate
Time Horizon Strategy
If you don’t calculate your time horizon well, you may end up losing money. For instance, if you were saving for a far-off retirement, but an emergency happened and you have to withdraw money, you will pay a steep penalty. First, there are early withdrawal penalties and taxes. But second, your money was not invested with a mind to taking it out now. You assumed you could ride out a market low. By taking the money out now, you are forced to take it at whatever value it happens to be at the moment.
For this reason, it is wise to invest separately for different goals if you can. Your emergency fund should be separate from your retirement fund. And if you’re saving for both a house in five years and a college education in fifteen, you may want these accounts managed differently.
In general, your investing strategy will change as time passes. As you get closer to retirement, your advisor will recommend switching out some of those long-term investments for more stable products. We’ve all heard of someone who lost much of the value of their account, right when they meant to retire. But if high-risk stocks are traded in for low-risk bonds as your retirement approaches, that won’t be you.
Get Professional Help
The job of choosing the right investment mix for every situation isn’t an easy one. A good advisor will also keep track of the passage of time, keeping an eye out for the right time to switch out higher-risk vehicles for stable ones. Find the right professional for you by contacting us today. Once they know your personal goals, they’ll be able to find a strategy that’s right for your time horizon.
