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 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.