Importance of Investment Time Horizons

By Amanda Holden · September 12, 2023 · 10 minute read

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Importance of Investment Time Horizons

When it comes to investing, your time horizon refers to the desired amount of time before you reach a financial goal. It’s one of the most important factors in your financial plan because the amount of time you have to reach your goal — whether it’s 3 months or 30 years — influences how much risk you want to take on, and therefore which investments you’ll choose.

In fact, a good way to think about your investing time horizon is like the leg of a table. Four key decisions uphold your investment portfolio, and the first is how much time you have, ideally, to attain a certain goal. The other three cascade from there: your risk tolerance, your investment choices, and your asset allocation.

What Is a Time Horizon?

What is an investment time horizon? In short, it is the expected time available to hold an investment or to achieve a financial goal.

First, an investing time horizon can refer to the amount of time that an investor is planning on holding an investment. For example, an investor may be planning to hold an investment for 10 years. Therefore, the investment horizon is 10 years.

Or, investors can think of a time horizon as a type of deadline: e.g. how long they plan to work toward a goal. For example, one common goal is to save and invest for retirement, which may be decades away.

This investing time horizon will likely be determined by the age of the investor and how much progress they are making towards their retirement goal.

An investment time horizon could also be short, long, or somewhere in the middle.

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Typical Time Horizons

Short-Term Investing Time Horizons

A short-term investing time horizon could be anywhere between zero and three years. Some examples of short-term goals include: saving up for a vacation, emergency funds, holiday gifts, or a down payment on a home.

For the most part, it makes sense to keep money for short-term goals in cash or cash equivalents, because the focus is generally on safety and liquidity — and investors won’t want to risk losing money that they’ll need relatively soon.

This can be especially true when the goal does not allow for any timing flexibility.

For example, say that you’re saving up for a down payment on a house in about six months. Because this is a short-term time frame, and because the objective is to make sure that the money is available for use in six months, it does not make much sense to subject this money to risky assets with high volatility, like stocks and bonds.

Cash can be held in a checking or savings account. This can be done with a traditional retail bank or an online bank account.

Another option to consider is a short-term CD at a bank or local credit union. Investors may be able to earn slightly more interest with a CD. Tread carefully, here: There may be a penalty to access money held in a CD before the maturity date.

For short-term goals that are flexible on timing, it may be possible to invest all or some of that money. For example, imagine an investor with the goal of starting a business in about three years.

Because they are flexible on timing, and willing to take on more risk in order to potentially see bigger gains, they may put some of their business start-up money into stocks or equity mutual funds or ETFs.

Recommended: Investing for Beginners

Medium-Term Investing Time Horizons

A medium-term investing time horizon could be anywhere between three and 10 years. Examples of medium-term goals include: starting a family or paying for a child’s college education, or potentially a house remodel.

Investing in mid-term goals can actually be more complex than investing for both short and long-term goals.

Likely, an investor will want to consider a balanced approach in a diversified combination of investments. The nearer the goal, the more bonds and cash the investor will likely want to have. The farther out the goal, the more risk that an investor might take.

How much an investor allocates to equities (stocks) will depend on their comfort level with the stock market during a medium investing time frame, and their willingness to be flexible.

Long-Term Investing Time Horizons

A long-term investing time horizon is generally longer than ten years.

Examples of long-term financial goals include: paying for college, retirement, financial independence, creating an endowment, and building intergenerational wealth.

How should long-term money be invested? In general, longer investment time horizons allow for more risk — which may set the stage for higher potential returns. Therefore, it is possible to have the majority of long-term funds invested in the stock market or similarly risky asset classes, if the investor’s personal risk tolerance allows.

The notion of risk is complex during longer periods, however. With money that is saved and invested now to be held for use over the long-term, investors may have to contend with losing purchasing power to inflation, in addition to market volatility.

Inflation is the economic phenomenon of rising prices, which means that over time each dollar can buy less. Historically, the inflation rate has run at 2% to 3%, which means money that’s “earning nothing” is actually losing 3% each year. Therefore, one of the biggest risks for long-term investors may actually be acting too conservatively, too soon.

Why Is Time Horizon Important?

Most financial goals have a time horizon attached to them implicitly, even if you haven’t spent much time thinking about it. If you’d like to buy a home, you might be thinking 2-3 years — or 10 years. If you’d like to buy a car, you might be thinking six months to a year. It all depends.

What drives the time horizon is the urgency of your goal. If you need a bigger home as soon as possible for your growing family, the goal of saving for a downpayment might be a short-term goal, with a shorter time horizon. If you want to buy a car, but you want to pay all cash, you might need a few years to save that money — so that goal would have a longer time horizon.

Goals like saving for college or retirement typically take years, and those time horizons are longer.

Once you can identify a realistic time horizon for the goal you’re investing toward, you can think about your investment strategy in more detail. Understanding the difference between short- and long-term investments is important, because some strategies will support your goals better than others.

Time Horizon and Risk Tolerance

Deciding on a short or long time horizon can help inform (or influence) your risk tolerance. Your tolerance for risk is, as it sounds, how much investment risk you can tolerate, when risk = the risk of losing money. If you can’t sleep unless you know your portfolio is relatively secure, and you’re on edge when markets are bumpy, you probably have a low risk tolerance.

Investors who have a low risk tolerance are considered risk averse, and they may prefer more conservative investments, like bonds. Low-risk investments like bonds and certificates of deposit (CDs) are less volatile, but they typically also have lower returns than higher-risk investments like stocks.

If you have a shorter time horizon of a year, and you don’t want to risk losing money, you may choose lower-risk investments like short-term bonds or types of CDs.

But if you have a higher risk tolerance, and you want to take on more risk with the hope of seeing higher returns, you might want to invest in stocks, mutual funds, or exchange-traded funds (ETFs).

Now let’s say you have a low risk tolerance, but you have a long time horizon to save for retirement: say 25 or 30 years. With a time horizon of three decades, your portfolio has more time to recover from periods of volatility, so you might feel more comfortable having a higher percentage of stocks in your portfolio, even though that increases your risk to some degree. It also increases your potential for growth over time.

This is often referred to as the risk-reward ratio, or a risk-reward calculation. Since no investment is genuinely risk-free, using a risk-reward ratio helps calculate the potential outcomes of any investment transaction — good or bad.

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Asset Allocation and Time Horizon

The purpose of deciding on the time horizon for your goals, examining your risk tolerance, and selecting different investments is to then land on an asset allocation that makes sense for you.

Asset allocation is the investor’s decision to divide a portfolio among various asset classes. Popular asset classes can include different types of stocks, bonds, as well as cash and cash equivalents (e.g. money market funds).

Asset allocation typically has a large impact on the performance of a portfolio over time. So, once again, an investor’s time horizon and risk tolerance will influence not only the selection of certain securities, but the proportion of higher- and lower-risk investments in a portfolio.

Asset Allocation Formula

For investors saving for retirement, there’s a general rule of thumb for deciding asset allocation. Subtract your age from 110, and that’s how much an investor should allocate to stocks.

If an investor is 30, subtract 30 from 110, which is 80. Thus the investor might consider an allocation of 80% stocks, with the other 20% going to bonds and cash. Of course, this is just a general rule — each investor will likely need to use their discretion and evaluate their overall financial profile and risk tolerance as they make investing decisions.

Investment Time Horizon and Risk Types

Investor’s must contend with different types of risk, depending on the time horizon for their goal.

Market Risk

This is the most common and likely the most well-known type of risk: it’s simply market volatility. The more exposure you have to the equity markets (or any market with greater volatility, e.g. crypto, commodities, high-risk bonds) that puts you at a higher risk for losing money.

While market risk is a factor for most investments to some degree, time horizon obviously impacts how much market risk you’re exposed to.

Inflationary Risk and Investment Time Horizon

As noted above, a big risk factor for longer time horizons is inflation risk: The risk that your money won’t grow enough to keep up with inflation. If an investor has a 20-year time horizon, for example, and invests conservatively during that time, there is a risk that they won’t end up with enough growth.

Interest Rate Risk

Interest-rate risk is the risk that interest rates could rise, affecting the value of the fixed-income part of a portfolio. While interest rate changes can impact many investments, bond values fall as interest rates rise.

Investing With SoFi

Your investment time horizon is effectively a type of financial deadline for any given goal. Some time horizons are more flexible than others — and that’s important to know, because the amount of time you have may influence your risk tolerance and investment choices.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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How do you calculate your time horizon?

Your time horizon is simply the amount of time between now (or when you start investing for your goal) and when you hope to reach your goal. For example, if you’re 35 and you’re planning to retire at 65, your time horizon for that goal is 30 years.

If you’re aiming to buy a home once you have $50,000 saved, you need to create a time horizon for when you’ll be able to reach that goal, based on the amount you can save per year, and your expected rate of return for the investments you choose.

What is the ideal investment horizon?

The ideal investment horizon varies from goal to goal. In the course of your life you may find yourself dealing with multiple time horizons for a range of goals. In some cases (e.g. saving for college or the arrival of a new baby), there’s an inflexible time horizon and you may have to adjust the amount you’re saving or the investments you choose. In other cases, like retiring or buying a home, you may be able to take more time to reach your goal.

Why is time important in investing?

Time is a critical element in all investing decisions, whether long term or short term. As its most basic, time may allow investors to save more, recover from market volatility, adjust their risk exposure (if needed), and potentially see greater gains.

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