Time horizon, investment horizon, planning horizon: all these terms refer to a timeline with a fixed point in the future at which you want to earn value on your investments. If you are willing and able to be patient until your time horizon turns in your favor, you can give yourself a competitive edge in the markets.
When it comes to your time horizon, keep your risk profile, long-term goals, and short-term goals in mind as you invest.
Time horizon and your risk profile
Having a long-term investment mindset is always challenging, but it may be more daunting now than ever. The economic unrest brought on by the pandemic has shown us how quickly new risks can complicate even the best of plans.
When allocating funds for investments, consider whether you need that money to live. For example, investing your only spare change or emergency fund may be riskier than you can afford. If you might need those resources in the short term, the risk is too high: a shorter time horizon increases the chance that you will experience losses.
This chart from A Wealth of Common Sense shows that the U.S. stock market was only positive 63.1% of the time for a one-month time horizon. In comparison, the stock market had favorable returns 100% of the time over every 20-year time horizon since 1926.
A shorter time horizon increases risk and limits the types of investments you can make. If your time horizon is shorter, you should rely on more stable investments with lower but steadier rates of return. A longer time horizon allows you to invest in a riskier portfolio with higher potential returns.
Time horizon and your long-term goals
Your Oakwell experts recommend planning for a minimum time horizon of five years, but there is no such thing as a time horizon that is “too long.” A time horizon of 20-30 years provides enough time for the market to achieve reliably positive returns.
Long-term goals can range widely, such as:
- Buying a second home or vacation home
- Preparing for retirement
- Creating generational wealth
- Inheritance investments
As you get closer to a time horizon checkpoint or endpoint, it is best to start structuring your portfolio to minimize volatility and value fluctuations. You do not want one of your riskier investments to decline unexpectedly and reduce the value of your accounts.
You can also expect your positive returns over a 20-year time horizon to outpace inflation over those same 20 years. This chart from a Dimensional article demonstrates how much a dollar can grow over time when invested compared to inflation.
It is unlikely you will achieve those same gains using cash savings, money market accounts, certificates of deposit, and other similar savings methods. The current annualized inflation rate in the United States is 6.2%, while the average interest rate for savings accounts is only 0.06%.
Time horizon and your short-term goals
If you have a goal to achieve in the next five years or sooner, your time horizon is too short to provide financial security. Unless you have separate resources you can invest over a longer time horizon, you should avoid using your short-term goal funds. Here are some examples of short-term goals:
- Buying a house or investment property
- Funding a big trip
- Planning a wedding
Short time horizons are more speculation than investment. Quick price changes and less security make you more susceptible to reactive investing and emotional decisions, tempting you to change your position when you see stocks jump around or you read trending news.
Consider this chart from A Wealth of Common Sense showing the performance of four different sectors and stocks between November 2020 to November 2021:
This chart shows that the energy sector increased by more than 94% while Zoom went down by almost 50% during the same period. However, if you expand your lens by just one year, the numbers tell a different story:
Between 2019 and 2021, Zoom’s stock actually increased by almost 330%, while the energy sector decreased by 1.82%. Given some time and patience, a longer time horizon makes it possible for you to experience much greater returns from seemingly volatile investments.
The most important things to know about your time horizon
The purpose of a time horizon is to give the markets time to achieve favorable returns. The only reliable way to achieve consistent returns is having a longer time horizon.
At Oakwell Private Wealth Management, long-term investment is part of our philosophy. We want to help you set a lifelong financial plan to keep you on course for your financial goals while retaining enough flexibility to adjust as things happen.
Your Oakwell team will consider factors such as your age and goals as we help you protect and grow your wealth. Through it all, we will keep you informed so that you understand what we are doing and how it benefits your financial health. We are committed to your success and disciplined in our approach to your financial plan and investments.
Do you have more questions for our experts? Are you ready to work on your financial plan? Contact the Oakwell team today.
The information contained in this article represents the opinion of Oakwell Private Wealth Management and should not be construed as personalized or individualized investment advice.