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Why understanding time horizon is important for your investments

05 Feb 2024

Planning for the future means knowing exactly when you can get hold of any money you have invested. Most of us will always need an exit strategy so that any cash we’re investing is not tied up forever.

That’s why it’s important to align the timeline of our goals with the kinds of investments we make.

What Is a Time Horizon?

Your time horizons refer to the periods during which an investment is tied up before you need your money back. It is a key drivers for the kind of investment portfolio you put together. It’s vital that they match your risk profile.

When time horizons are longer, an investor has the chance to be more aggressive with their portfolio. To put this into context, the stock market typically drives the risk through equity mutual funds or individual stocks.

Should the stock market take a dive, a lengthier time horizon builds in more potential for the portfolio to regain its value. Although there are no set guidelines for time horizons, it’s useful to see them in these three ways:

1. Short-term goals would be those under five years in the future. Were markets to fall, this kind of time horizon might be too tight for any portfolio exposed to equity funds or stocks to recover. That’s why short-term time horizons typically use cash investments such as savings accounts or money market funds. They are ideal for investors with a low-risk profile and who need quick access to their cash.
2. Medium-term goals refer to those between 5 and 10 years in the future. Investing often means a mix of high and low-risk assets. A balance of stocks and bonds would be an appropriate way to protect a portfolio without losing out to inflation.
3. Think of long-term goals as being more than 10 years away. Such a long period of time exposed to stocks might offer the chance of greater return. The lengthier the time horizon, the more time the power of compounding has to work. Typical long-term investing would include retirement savings. Long-term investing generally means a higher level of risk in the hope of a greater reward.

The Right Strategy for You and Your Portfolio

All investors should weigh up their own goals and investment timeline before they decide where to put their money. Once they have a clear idea of where they want to be in the future, they can decide what is the optimal balance of rewards and risk for their portfolio.