Refers to the total amount of time you expect to hold an asset.
Every investor wants their assets to increase over time, so they can eventually use that money to buy something or enable them to retire.
Every investor has different motivations for investing. Some of the most common reasons for investing are:
- Beat inflation
- Reach a financial goal like buying a home, starting a business, or funding education
- Reduce taxable income
- Get in early by investing in a start-up company
The investment you choose and how much you attribute to that asset depends primarily on your time horizon. The investment horizon is the total amount of time you expect to hold an asset.
Generally, older investors tend to have their cash invested in more conservative assets accompanied by less risk. This is because they are more likely to need the money soon, and periods of significant volatility can devastate their portfolios.
Younger individuals tend to have a longer investment horizon and invest in riskier investments to earn higher returns potentially. Funding for the long term makes periods of volatility less detrimental to your portfolio, as there is more time to recover from losses.
Your age and the target date of your financial goals affect your investing horizon.
Types of Investment Horizons
You need to consider how long you plan on holding security before investing. Time plays a crucial role in the performance of stocks, bonds, mutual funds, ETFs, and all other types of investments.
There are three general types of horizons:
Many investors will be involved in all three or several time horizons. However, individuals at different stages of their lives may be more committed to specific time ranges. For example, older people will more likely be focused on short- and medium-term horizons.
Typically, the longer the horizon, the more risk you are willing to take because you will likely not require access to your funds anytime soon. However, this is not always the case.
Consider your time horizon and understand your risk profile to ensure an investment makes sense for your financial situation. But, of course, your time horizon is also okay (and expected) to change as your financial situation and age change.
Investors with a short-term horizon tend to be older. They are individuals that will likely need the money within five years. This tends to be retirees because they may need the cash to fund their lifestyle when they no longer have a reliable income stream.
This time range could vary from a few hours to five years.
However, this can also include people who have short-term financial goals, such as buying a car. Many individuals will invest a portion of their savings for their purpose in a bond or low-risk stock because it will likely have higher returns than a traditional savings account.
Examples of short-term goals include:
- Car payment
- Gap year travel
Short-term investments, while often safer, tend to have lower yields. These types of investments are usually intended to maintain the value of your original investment rather than produce high returns.
Investors in this category tend to be more risk-averse, often reluctant to take on more risk.
Some examples of safer investments for short-term time frames are:
- Money market funds
- Certificates of deposit
- Short-term bonds
Liquidity is also necessary with short-term investing to allow easy access to your money.
For instance, let's say you are saving money for a down payment on a car in one year. You know you will need the money, so you want to ensure your investment doesn't lose value. One option could be to put the cash in a short-term certificate of deposit.
This would allow you to earn a higher interest rate on your deposit but with minimized risk. However, you must ensure you will not need to withdraw the money before the maturity date to avoid paying a fee.
An example of asset allocation for the short term is:
- 70% cash
- 20% bonds
- 10% stocks
Medium time horizons typically mean you do not plan on selling the security for five to ten years. This includes individuals who are less risk-averse and do not have specific long-term plans for their investment.
Examples of medium-term goals include:
- House down payment
- Children's education
- Home Remodel
The length of a financial goal depends on each investor's financial situation, as some may have a higher income or less debt than others, which affects how much someone can contribute to their goal.
Medium-term investors are in the middle of being conservative and aggressive. As a result, they tend to have portfolios with a mix of stocks and bonds to provide higher returns and reduce risk. This mix of securities will protect you from significant losses.
Additionally, exchange-traded funds (ETFs) can be a valuable asset for medium-term investors because they have the potential for higher returns but come with less risk than stocks.
For instance, let's say you have a child who will need tuition in nine years. With the extended period, you can afford some risk, but you should be cautious because you cannot afford to lose a significant portion of your investment.
One option could be to invest in a mix of stocks and bonds. This asset allocation depends on your target amount and how much risk you can afford.
An example of asset allocation for the medium term is:
- 10% cash
- 40% bonds
- 50% stocks
Long-term investors are more aggressive and not high-risk averse because security is more likely to grow over an extended period. As a result, shorter periods of volatility are often irrelevant over long periods.
The time frame for long-term investing is a horizon longer than ten years. Many people begin saving for retirement early in life. They support this money instead of putting it in a savings account because they will not need access anytime soon.
Examples of long-term goals include:
- Children's education
- Starting a business
While there is often more risk associated with long-term investing, the potential returns are also greater. In addition, long-term investments make sense for young people who can invest cash they will not need soon.
Due to compounding, time can be your biggest ally in investing. Compounding enables your investment to grow exponentially, and investing early in life can pay big dividends.
An example of asset allocation for the long-term is:
- 90% stocks
- 10% bonds
Risks Associated with Investment Horizons
There is always some risk associated with investing, especially in stocks. Below are a few of the most common threats your investments may be exposed to:
- Inflationary risk refers to the possibility that inflation is higher than the returns on your investments. This causes the actual value of the asset to decline. Bonds are particularly susceptible to these risks.
Interest rate risk concerns unexpected changes in interest rates. This is primarily a concern for bonds and other fixed-income securities. This risk can be reduced by holding bonds of various durations.
- Business risk refers to the possibility of a company failing or declaring bankruptcy. This causes your assets to lose value, possibly becoming worthless. The most effective method to reduce exposure to this risk is to maintain a diversified portfolio.
- Like business risk, market risk acknowledges the stock market's volatility. Large-scale events, speculative behavior, and market crashes can all affect the value of your investments.
This is typically a risk more relevant for short- and medium-term horizons because, over a long period, investments are more likely to increase in value.
- Default risk is the likelihood that a borrower cannot repay their debts. This is particularly relevant to debt-based securities such as bonds. This risk can be limited by investing in bonds with higher credit ratings.
Let's say you have recently graduated from college and have been living in an apartment in the city for two years. At twenty-four years old, you are looking to move into a home in a local suburb with your partner you've been with for years.
You have finished paying off your student loans but plan on getting a used car within the next six months. You have a little over half of the cost saved up but need to figure out where to put the cash from your savings account to earn more Interest.
In this case, purchasing a car is a short-term horizon, so you want to look for something conservative but with a higher yield than your current savings account, which only pays 0.75%. So you decide to put the money into a 6-month certificate of deposit with an APY of 1.85%.
Next, you want to make a down payment on a house in 6 years but still need to generate more cash. This is a medium-term horizon where you have more time to take on riskier investments. You do not need the money soon and are willing to take on some risk.
You decide to invest 60% of the cash into funds like the Vanguard S&P 500 ETF (VOO) and the Vanguard Dividend Appreciation ETF (VIG). You notice that the historical performance over the past five years for VOO has been 12.5% and 12.4% for VIG.
You are comfortable with the safety of these investments and understand there is a slight possibility that the assets will lose value. Therefore, to diversify your portfolio, you also put 30% of your cash into a high-yield bond index, such as the Vanguard High-Yield Corporate Fund (VWEHX).
The remaining 10% of the cash is kept in your traditional savings account as a safety net if you have to renew your lease in a few years because the other securities lost value.
Additionally, you plan to marry your partner soon and understand that the wedding will be expensive. This could be a short- or medium-term goal, depending on when you end up getting married.
Because you are uncertain about when you will get married, you decide to invest 40% in stocks, 30% in bonds, and the remaining 30% in a high-yield savings account.
Meanwhile, you are already beginning to plan for retirement because you are a knowledgeable investor and understand your investment horizon. In addition, you have taken advantage of your employer's 401(k) savings fund, which your company matches.
You do not plan on retiring for at least thirty-five years, so you devote 90% of your portfolio to stocks to maximize potential returns. Given that you do not need the money anytime soon, you are comfortable with a portfolio of primarily stock risk.
Your asset allocation determines how much risk you subject yourself to. For example, investors with long-term horizons are likely to invest more heavily in stocks, while short-term investors often have more bonds.
This is a suggestion on asset allocation by age, but note that your asset allocation depends on your financial situation and investing profile.
As you age, your portfolio may require rebalancing to align your asset allocation with your risk tolerance.
Diversification is the key to providing a balance of potential risk and return. Diversifying your portfolio limits your asset-specific risk, so if one company or sector underperforms, your portfolio doesn't lose all of its value.
Your asset allocation should change as you age and your investment horizon adapts.
Your investing horizon depends on your financial goals, age, and. This calculator by SmartAsset enables you to look at your potential returns depending on how much you contribute and how many years you allow your portfolio to grow.
For example, if you started with $10,000 and invested $5,000 annually. Assuming an 8% return per year, after 30 years, your portfolio would grow to $667,043.
Note that, after, the average stock market return is 7-8%. This is based on the performance of the S& .