Defining your investment time period, or time horizon is an essential step in forming an investment strategy that works for your specific goals.
What should you know before your first investment?
If you’re meeting with a financial advisor for the first time, you will notably be asked about
- Your financial situation
- Your knowledge and experience
- Your investment objectives
- How much do you want to invest
- The risk you’re willing to take
- The period for which you’re willing to stay invested
That’s because this information helps them create an investment strategy best suited for you.
When you define an investment goal and the consequent time horizon, it determines the period over which your investment portfolio needs to work and a specific point in time when you need your money back.
Why are time horizons important?
When you define an investment goal and the consequent time horizon, it determines the period over which your investment portfolio needs to work and a specific point in time when you need your money back.
Think of investing as the act of planting a seed, watering it, and replenishing the nutrients in the soil when needed. Now, let’s assume you want to invest in an apple farm with a specific goal – to sell part of the produce to grocery stores, and to make juice out of the remaining apples. You feel this could be a healthy alternative to soda for your newborn twins in a few years when they are old enough to attend school.
Given the specific nature of your goal, you know that your investment horizon is around 5 years – around the time when your kids are ready to begin school.
What’s the risk got to do with it?
Some of your apple trees might not make it because of factors like droughts or hailstorms. Or your children could be allergic to apples. These would be the risks you take when you invest.
Now, imagine if instead of a time horizon of 5 years, you only had 2 years to get your apple farm up and running, because your kids were a few years older when you began investing. Now if a drought or hailstorm hits your farm in the first year, you barely have any time to recover and adjust to meet your goals. Longer time horizons tend to mitigate the risks of volatility and give the investments time to grow.
Before investing it might be valuable to ask yourself: “Of the money I have, how much would I NOT need during my time horizon?” Answering this question could give you a fair idea of what you’re willing to lose in case the market crashes and help you set your risk appetite.
Before investing it might be valuable to ask yourself: “Of the money I have, how much would I NOT need during my time horizon?”.
What factors affect a time horizon?
Changing market conditions
In time, the apple trees might grow in value, and you might want to sell them to buy real estate or start another project once your kids grow up and begin to choose their own drinks. Investments tend to behave similarly, and you might not only profit from regular returns but also potentially from an increase in their value.
Changing human conditions
You should also consider that other important events can occur in life and take that into consideration as well. In the example, a third child might be on the way. Or perhaps your ability to invest changes over time – maintaining a farm is a tough job after all. Changes in income and lifestyles have an impact on your time horizon. If you were investing closer to your planned retirement age, would you be willing to take a significant risk?
Generally, younger investors without parental obligations tend to have longer time horizons for their investments. Of course, that completely depends on the personal life goals one wants to achieve.
If you’re interested in learning more about time horizons, investing goals and how to navigate the world of investing, sign up for our free Masterclass and receive a 10-part email series straight to your inbox.
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