The Importance of Time Horizon when Investing
Time horizon refers to the length of time you are able to invest before you will need the invested money.
If you are investing to take a vacation in three years, you may invest quite differently than if you are investing to fund your retirement in 20 years.
How long your investment has to grow will impact the degree of risk taken. In general, the longer the investing period the more aggressive the investment can be - as there is time for the market to recover from any downturn.
As markets go up and down, having the ability to wait out a market decline is a valuable tool in growing wealth.
To match investment risk to time horizon, you can make a list of the goals for which you are saving and investing and the number of years until you will need the money.
1. Take a vacation: 1-2 years
2. Become a parent: 3-5 years
3. Buy an apartment: 5-7 years
4. Start a business: 10 years
5. Contribute towards college tuition: 18-20 years
6. Retire - 25-35 years
In general the farther away the goal date the more aggressive the investment can be, as there is time to recover from a downturn.
When you expect to need the funds in the short-term risk should be limited to ensure you have sufficient funds to meet your needs.
You may hear people generalize that bonds or even money market funds are better for short-term goals than stocks. This conclusion may or may not be optimal for you. Consideration should be given to your personal situation, your existing portfolio, retirement accounts and alternative sources of funds, your risk profile, and your time horizon for each and all of your goals.