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When evaluating an investment opportunity, it's important to consider a variety of factors, including when you plan to sell the investment—also known as your time horizon. Depending on your situation and financial goals, you could have different time horizons for different investments. Here's what you need to know.
Understanding Investing Time Horizons
An investment time horizon is the amount of time you expect to hold your position before you need the money back.
Depending on the goal, your time horizon could be a specific date or a more general time period. Your time horizon for a specific investment goal will help determine how much risk you're willing to take with your portfolio.
For example, if you're saving for college, your time horizon will be the month you expect your child to begin college. For a 12-year-old, for example, that'll be roughly six years. However, if you're a young professional saving for retirement and only have a general idea of when you want to leave the workforce, you may simply have a long-term time horizon.
Here's a quick summary of the most common time horizon periods.
Short-Term Investment Horizon
This is typically a horizon of a few years or less. If you have a short-term horizon, you'll typically want to put your money into relatively safe investments, such as short-term corporate bonds, certificates of deposit (CDs) and Treasury bills.
Medium-Term Investment Horizon
This time horizon period typically lasts between three and 10 years. For this type of investment goal, you may consider investing in a mix of aggressive and conservative investments, such as stocks, medium-term corporate and government bonds, mutual funds and exchange-traded funds (ETFs).
Long-Term Investment Horizon
If you have an investment goal that's more than 10 years out, you may be able to invest in more aggressive and long-term investments. In addition to stocks, mutual funds and ETFs, you could consider long-term corporate bonds, real estate and private equity funds.
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How Does an Investment Time Horizon Affect Your Portfolio?
Financial markets tend to experience a lot of volatility in the short term. As a result, your time horizon is one key indicator of how much risk you can comfortably take on with your investment portfolio.
The longer your time horizon, the more risk you can take on without worrying about short-term fluctuations impacting your return. A longer investment horizon also typically means greater potential for your portfolio's future value. Because high-risk investments also tend to have high return potential, it makes more sense to be aggressive with your long-term investment goals.
On the flip side, having a short-term investment horizon means that you can't afford to take on a lot of risk. At that point, preventing losses takes priority over accumulating more wealth. If you're nearing retirement or another important investment goal, your best bet is to focus on low-risk investments that you can easily liquidate and convert to cash.
How to Invest With Time Horizons in Mind
It's important to consider your time horizon not only as you develop your investment strategy but also as you continue to manage your portfolio. Here are some ways to implement your time horizon throughout the process:
- Consider risks. Each time you evaluate an investment, consider both the return potential and the risks to determine whether it's a good fit for your goal. Remember, you can generally afford to take on more risk with long-term time horizons because short-term volatility is less likely to impact your return.
- Tailor your investment choices to your goals. Your time horizon is unique to your investment goal, so if you have multiple goals, you'll need to make decisions based on your investment horizon for each one.
- Reallocate your assets over time. Asset allocation involves investing in different assets to balance the risk and reward of each type of asset. As you near your time horizon, you'll want to evaluate your asset allocation and make adjustments, selling off riskier investments and buying lower-risk investments to preserve your gains.
- Consider target-date funds. A target-date fund is a mutual fund or ETF with a specific time horizon in mind. Fund managers will adjust the fund's asset allocation over time based on the target date, reducing the fund's risk over time so you don't have to. If you want a hands-off investment for retirement or college savings, a target-date fund could be worth considering.
The Bottom Line
When you're evaluating an investment opportunity, it's important to consider a variety of factors, including when you plan to sell the investment and reap the gains. Over time, you'll also want to adjust your portfolio so that it stays in line with your investment goals.
If you're feeling overwhelmed with the process, consider consulting with a financial advisor who can provide guidance or even manage your investment portfolio on your behalf.