Understanding Investment Horizon
Let me explain what an investment horizon really means—it's the total length of time you, as an investor, expect to hold onto a security or your entire portfolio.
You need to grasp this concept because it defines how long you're planning to keep your investments before cashing out or reallocating.
Basics of Investment Horizon
Your investment horizon can be as short as a few days or stretch out over decades, depending on your situation. For instance, if you're a young professional building a 401(k), you're looking at a horizon that lasts for many years. On the other hand, a company's treasury team might only hold investments for a couple of days.
Some strategies, like those relying on technical analysis, operate on even tighter timelines—think days, hours, or minutes. The key point here is that the length of your horizon directly affects the risk you're exposed to and what kind of returns you need.
Generally, with a shorter horizon, you'll opt for less risk in your portfolio. That's why establishing your investment horizon is one of the first things you do when building a portfolio.
Investment Horizons and Portfolio Construction
If your horizon is long, you can afford to take on more risk because the market has plenty of time to bounce back from any downturns. Take someone with 30 years ahead—they'd likely put most of their money into equities.
Going further, with that long view, you might even dive into riskier equities like mid-cap or small-cap stocks. These can swing wildly in the short term due to their vulnerability to economic shifts, but over 30 years, those fluctuations don't matter much.
As your horizon gets shorter, you should adjust your portfolio to dial down the risk. For example, retirement portfolios often cut back on stocks and boost fixed-income holdings as you approach retirement age. Fixed-income options offer lower long-term returns than stocks, but they bring stability with fewer sharp price drops.
Key Takeaways
- An investment horizon is the time you're willing to hold your portfolio.
- It matches up with the level of risk you can handle.
Example of Investment Horizon
Consider Carol, who's 30 and works as a software engineer. She has a long-term horizon and prefers low risk, so she puts her savings into a home and fixed-income securities set to mature over the next 30 years.
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