What is Investment Horizon?
Investment horizon is a term used to identify the length of time an investor is aiming to maintain their portfolio before selling their securities for a profit. An individual’s investment horizon is affected by several different factors. However, the primary determining factor is often the investor’s risk tolerance.
Investment horizons are a critical piece in portfolio investing because they help determine the amount of time an investor will hold their investments to compensate for the risks that they take when investing.
Breaking Down Investing Horizons
Individuals in their early investing years are the most likely to have longer-term investment horizons. This is simply because they have more time to make a profit from their investments or recover from losses sustained when taking risks. For the same reason, they are also more likely to make riskier investments with the potential for a greater payoff down the road.
Seasoned or older investors are more likely to use a shorter horizon because they have less time to realize profits.
Three Types of Investment Horizons
1. Short-term investment horizon
First, let’s talk about the short term. This investment time frame, as mentioned above, is typically best for individuals in their later years, preparing for retirement. It may also be appropriate for individuals who are strongly averse to risk or need to access a significant amount of cash in the near future. A short investment horizon usually doesn’t exceed a period of three years. For these risk-averse investors, it’s best to have guaranteed assets or securities, including high-interest savings accounts and certificates of deposit.
2. Medium-term investment horizon
Investors who are less risk-averse and not looking for cash for retirement or a large purchase are better suited to a medium-term investment horizon. This usually means a period of three to ten years. Investors with this type of investment horizon are somewhere in the middle between low and high risk, meaning a conservative and diversified portfolio is best, mixing investments in both stocks and bonds. The ratio of stocks to bonds should be determined by the individual’s specific wants and needs.
3. Long-term investment horizon
Finally, for investors willing to take big risks for big rewards and who have the time to wait for the payoff or to recoup losses after risky endeavors, long-term investment horizons are often the way to go. In most cases, the portfolio of the long-term investor includes a significant amount of risky investments with potentially high yields. The remainder of the portfolio should then be a mix of stocks and bonds, with the ratio leaning more heavily towards stocks.
Every investor must determine the amount of risk they are willing and able to tolerate and how much time they can devote to maintaining their portfolio before needing to access their profits. These key elements affect the investor’s investment horizon, which ultimately affects what they fill their investment portfolio with.
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