What Is An Investment Time Horizon?


An investment time horizon can be broadly defined as a timeline that investors use to determine the length of time they need to hold an investment before realizing profit. Investment time horizons help investors understand how much time they realistically have to reach their financial goals. In other words, this can help an investor assess how much time they need to hold onto an asset before selling. It can also provide a way to assess their risk tolerance or risk capacity as an investor. This information may be used to determine what mix of investments to include in their portfolio.

At its core, a time horizon provides the answer to the question: when does the investor expect to realize their profit?

Time Horizon Defined

To be more specific, an investment time horizon is the amount of time an investor needs, or expects, to hold an investment before they may decide to sell it. The length of the horizon is largely affected by the amount of time you need to reach a certain financial goal. It could vary from months to decades, such as with retirement savings plans.

The longer the time horizon, the more aggressive an investor may be when building their portfolio, choosing riskier investments over more stable alternatives. With a shorter time horizon, investors may choose to be more conservative with their traditional assets, such as stocks and bonds, choosing stability over risk. In the case of real estate, however, shorter term investments may prove riskier than longer term assets.


Types of Time Horizons


Most investors tend to have multiple financial goals they want to meet. As an investor, you benefit from keeping the calendar in mind as you build your portfolio and look for assets that fit your goals.

There are three different types of general holding periods used to designate the length of the time horizon: short-term, medium-term, and long-term.

Short-Term Investment Horizon

The short-term horizon refers to investments expected to last for fewer than five years. Traditionally, this type is appropriate for investors who are approaching retirement, may need capital on a tight deadline, or who are less risk averse. In commercial real estate, this is not necessarily true. Investments in commercial property, especially those that are held for 3-5 years, can potentially present more risk but also have the potential for solid returns. Different assets perform differently, so it would benefit any investor to keep that in mind when choosing what to add to their portfolio.

Medium-Term Investment Horizon

This is for investors who expect to hold onto their assets for longer than five years and up to ten years. Examples include people who are saving for a new home or those who may want to increase the amount of money they have saved up for a college fund. Medium-term strategies tend to balance between high and low risk assets, which can potentially protect existing wealth without losing value to inflation, while also seeing capital appreciation.

Long-Term Investment Horizon

Investors using this strategy expect to hold their investments for ten or twenty years, sometimes even longer. A well-known example would be saving for retirement through a 401k. The more time you have, the more you can potentially afford to deal with risks in your investment portfolio. In real estate, long-term investors may take greater risks in return for potentially greater rewards, however many look for stability.

No matter your time horizon, as you near the target date for your financial goal, it may benefit you to begin to shift your portfolio’s mix toward more conservative assets to minimize the risk. Of course, time horizon and risk tolerance are strongly related, as an investor’s overall inclination toward taking risks affects how they build up their portfolio.

Why Understanding Your Time Horizon Is Important


It’s important to know your time horizon so you can properly outline an investing strategy that meets your goals. One of the biggest mistakes an investor can potentially make is not aligning the timeline of their goals with their investment types. The time horizon dictates the return of your investment versus the return on your investment.

To illustrate what is meant, take this example. With a shorter time horizon, your focus will likely be tilted toward preservation of capital. You want to make sure you get your initial investment back plus whatever growth was achieved. If you need the money by next year, there isn’t a lot of time to grow your investment, so you do not have a lot of room to risk losing it. If your time horizon is longer, you’ll likely focus on the returns on your investment.

Alternative Investments And Time Horizons


Alternative investment classes generally tend to be more illiquid than traditional investments such as stocks and bonds. This means they’re typically suitable for those investors with a long-term strategy. For example, venture capital funds usually last about ten years. These investors commit a certain amount of money to a venture capital firm that uses it to invest over the next decade, along with capital from other contributors.

Real estate is another example of an alternative investment that may require a long-term horizon, though most properties may lend themselves well to short or medium-term horizons.

For investors with a short-term horizon, they will likely want to preserve the liquidity of their assets. As a result, they may only want to invest in commercial real estate through a publicly traded REIT, since the shares can be purchased and sold much like stocks can. Others might focus on investing in deals with solid cash flow at that point in time. For those nearing the end of their short-term horizon, they are likely to invest in safer assets with stable income and a greater potential of preservation of capital.

Investors with a medium-term horizon will likely pursue a more diverse investment approach. This may look like investing in neighborhoods with strong local economies and healthy job markets. They might also choose to invest in value-add real estate assets in order to improve the property and cash out their original investments alongside their profits once the property is fully stabilized.

Those who have a long-term horizon, typically more than 10 years, tend to have the most flexibility in investing. The longer period allows investors to add potentially riskier investments to their portfolio, such as ground-up developments or secondary and tertiary markets that show promise but are not currently stable enough to grow. Of course, the smart investor will still balance this out by investing in some assets that carry minimal risk, such as the examples used in short and medium-term horizons.

There are many elements of real estate, both commercial and residential, that prevent real estate assets from being as quick a turnaround as stocks and bonds. One of those is the illiquidity of this type. Rarely can a property be sold for cash at a moment’s notice. As an investor, it would benefit you to keep this in mind when diversifying your assets and choosing which to include in order to fit your time horizon.

Potential Risks


Each type of investment carries different risks, and an investor would benefit from considering this when planning their financial and investment strategy. This is why it’s important to consider how you will diversify your portfolio to fit your time horizons. Here are some of the risks to consider when deciding on your personal time horizon.

Inflationary Risk: This refers to the danger that the real value of an asset will fall due to an unexpected increase in consumer prices. For example, bonds tend to be susceptible to inflation, meaning an unexpected spike could possibly negate the expected gains from this investment.

Interest Rate Risk: An unexpected rise in interest rates could affect some of the gains on an investment. Like inflationary risk, this mostly applied to what are considered “traditional” investment types such as stocks and bonds. This can also affect real estate if you have variable rates on the debt of an investment.

Business Risk: This is the risk that a company might fail or go bankrupt, causing the stocks, bonds or other investment type issued by that company to lose their value.

Default Risk: The probability that a borrower will be unable to repay its debts is considered default risk. This tends to refer to bond issuers but can also refer to other debt-based investments.

Market Risk: Also known as volatility risk, this refers to the chance that the value of an investment will be negatively impacted by market crashes or other world events. Since markets tend to trend upwards over the long term, this type of risk is usually more of a concern for short- and medium-term investment horizons.

All of these can be mitigated through various strategies, such as diversifying your portfolio or choosing traditional investments with high credit ratings. Knowing your time horizon can help you choose both the right investment and the right risk mitigation strategy suited to your needs.

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