What is Time Horizon?
Time horizon measures an expected holding length of your investments and this term is often mentioned in relation to an investment strategy, meaning that a particular strategy (approach) can prefer a certain holding length. Some strategies, such as “buy and hold”, have a long time horizon, contrary to the day trading strategies which have an extremely short time horizon and, of course, there are many strategies in between.
Time Horizon in Action
Let’s say we’re examining a conservative investment portfolio.
The goal of this conservative investor is to make a 5% return on his capital of $10,000 in the next 12 months and then, maybe, to sell everything and spend it on a nice vacation. So, he decided to purchase some short-term bonds with a 3.5% guaranteed return and he also bought some stocks with an average historical return of 7%. We can see that this person has a relatively short time horizon because the expected length of investment is only 1 year.
Long-term vs Short-term Investments
Generally speaking, short-term investment is a deal within the period of 1 to 3 years and a long-term investment may take 5 to 10 years or more and a time frame of 3-5 years can be considered a mid-term investment.
It’s possible to allocate a portion of your portfolio to various short-term investments and to allocate the rest of your portfolio to the longer-term investment opportunities. These days, there are many traders with a super-short time horizon of 1 to 30 minutes who make a lot of deals in a non-stop fashion. Calling such an investment horizon “short-term” would be an exaggeration, those traders are called “day traders”.
You can read more about the difference between trading and investing, which is a very close topic to the time horizon. Investors have a long-term strategy and view, they create a portfolio that will keep the most of its structure for a long period of time of 5-10+ years. Traders are those market participants who operate short-term and make a large number of deals regularly.
Why Time Horizon is Important?
For any investor on the market, a good understanding of the time horizon concept is crucial because it helps to determine an optimal investment strategy and pick the right assets for a portfolio.
Time horizon and investment goals help to determine the best investment strategy for a particular investor. If someone wants to make money without significant risk and he has a short-term horizon, he would be limited to low volatility investments such as bonds. Those kinds of investments can guarantee you a certain income without a significant downfall risk but they are usually less profitable than stocks. The issue with stocks, however, is that they are not compatible with short-time horizon because they are quite volatile in the short run.
New market participants often make a mistake of ignoring the time horizon so they would just buy “the best” stock with the highest expected return because they think that it’s a good long-term investment, thus it must also be a good short-term option and they can always sell it if something goes wrong.
This pattern of thinking leads a lot of amateur investors to huge financial losses.
Before creating your portfolio, you should figure out your time horizon and pick your assets accordingly.
In simple words, it’s a good idea to ask yourself the following questions:
- Is this a long-term or a short-term operation (trade)?
- When am I planning to close this deal?
- How much money am I planning to gain with this portfolio? What is the expected return?
- What is my general strategy with the whole portfolio and what is the approach? Is it long-term or short-term?
Determine your own time frame for each portfolio. Consider using target-date funds, fixed income bonds and other instruments which have guaranteed returns to achieve more stable outcome, especially in the short run.
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