What Is Horizon Analysis?
Let me explain horizon analysis directly: it compares the projected discounted returns of a security or an investment portfolio's total returns over several time frames, which we often call investment horizons. You should know this is mainly used to gauge the expected performance of portfolios made up of fixed-income securities, like bonds. As a portfolio manager, I can use horizon analysis to evaluate which bonds would perform the best over your planned investment horizon.
Understanding Horizon Analysis
You need to understand that horizon analysis relies on scenario analysis to give a more realistic estimate of an investment or portfolio's performance. I typically apply this to portfolios of fixed-income securities, such as bonds. The framework lets me, as a portfolio manager, project bond performance based on your planned investment horizon and expectations about risk levels, interest rates, reinvestment rates, and future market yields.
By breaking down expected returns into different scenarios, you can see which bonds would perform best over that horizon—something you couldn't do just with yield to maturity (YTM). This approach shows how sensitive a bond's performance is to each scenario and whether it aligns with your goals over the expected time frame.
Similar Term
Don't confuse this with horizontal analysis, which is used in financial statement analysis to compare historical data like ratios or line items over several accounting periods.
Investment Horizons and Portfolio Construction
When you have a longer investment horizon, you can take on more risk because the market has plenty of time to recover from any downturns. For instance, if your horizon is 30 years, you'd likely allocate most of your assets to equities. Beyond that, with a long horizon, you might invest in riskier equities like mid-cap and small-cap stocks. These tend to have larger price swings over short periods because they're less established and more vulnerable to economic forces.
Those short-term swings don't matter much if you're holding for 30 years. As your investment horizon shortens, you should adjust your portfolio to reduce risk, often by cutting back on equities and increasing fixed-income assets, especially as you approach retirement. Fixed-income investments offer lower long-term returns than stocks but add stability with less dramatic short-term price changes.
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