An investment time horizon is the length of time investors hold an investment until they need the money back. Without knowing how long you want to or need to stay invested, investors may not be adequately allocating capital to the right asset classes to help them achieve their financial goals.

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What is an Investment Time Horizon?

As an active investor, it can relate to the time you hold a certain company before the thesis plays out. As a passive investor, it may be the length of time an Investment Strategy such as a retirement fund is adhered to. Or a combination of both.

The time horizon is a crucial component of building your investment philosophy. This will often drive your strategy, process, and portfolio asset allocation. There are a few different ways you can look at this. I, for the most, part agree with the modern approach to time-horizon, which is based on 3 approximate lengths of time, short-term, medium-term, and long-term. However, I also have a different perspective which brings in how it can correlate with risk over the long haul.

Why is an Investment Time Horizon important?

Knowing your time horizon can help investors structure a strategy that considers risk when looking at achieving a financial goal. The usual approach is the longer the time horizon, the investor can take on more risk, perhaps with a 100% stock allocation. The reason is they have more time for their portfolio and holdings to recover should a market downturn occur. The short-term approach is to usually avoid higher-risk investments because the capital may need to be accessible. Therefore, too much risk over a shorter period may wipe out the capital needed to achieve a goal.

The first stage of building a portfolio and investing is to consider risk and time horizon together. The curve chart below shows how I think about investing and time horizon. Once investors understand their time horizon, they can select the most suitable investments across the asset classes that will help them achieve this goal.

Questions such as, should I invest in bonds or a fixed-term deposit? Should I invest in high-growth stocks? Perhaps mature dividend-paying companies? These questions can be answered more clearly once an investor understands their Risk Profile and the length of time they want to stay invested.

A look at how time, asset class and risk interact.

The below table shows how investors can think about time, risk and asset allocation. As time goes up, so does the risk which changes the asset allocation.

TIME HORIZON	RISK LEVEL	ASSET CLASS
1-3 Years	Preserve Capital / No Risk	Cash / Bank Term Deposits
3-5 Years	Preserve Capital / Slight Risk Taking	Cash / Bank Term Deposits / Short Term Bonds / Blue Chip
5-10 Years	Balance of Growth & Preservation / Moderate Risk	Stocks / Bonds / Diversified Assets / Blue Chip / Index Fund
10-20 Years	Growing Capital / Higher Risk	Stocks / Growth Assets / Alternative Assets / Small-Caps
20-30 Years	Grow Capital | *Moderate to High Risk	*Above + Index Funds / Dollar Costing / Buy and Hold.

Now why have I chosen to come down the curve post 20 years as opposed to staying with higher risk assets? I believe if you have a time horizon of 20+ years then it will come down to long-term discipline and a consistent investment strategy that can achieve great results. For example, let’s assume you dollar cost average into an Index fund, say the S&P 500 or the ASX 200, for 25+ years all dividends are reinvested. Whilst there is market and economic risk, active stock selection risk is eliminated. The length of time due to the power of compounding can still provide investors with a good return without increased risk.

I love the way Howard Marks explains his approach to Risk. We don’t reward or acknowledge investors who achieved an average return but with far less risk. That is something to be applauded for. That is why if you are in your 20s and 30s sticking to an investing strategy for 3 decades without actively seeking out stocks and pursuing higher returns by taking on higher risk can still create wealth.

Short-Term

If you will need access to your funds within the next few months or years, your time horizon would be considered short-term. Savings and low-risk asset classes are ideal.

Liquidity is the driver of this. Investing in assets that can be converted to cash with minimal volatility is important. The reason why most opt out of stocks is because large corrections can happen. Whilst stocks over the long run tend to show stable 8-12% returns, that does not occur every year. It is lumpy. If you need cash for a down payment on a house or a gap year, you cannot risk losing a good chunk of that capital.

Medium-Term

A medium time horizon can have a balance of growth and income-producing asset classes. You have the time to see stocks rise, index funds grow, seeing bonds to maturity. A combination of conservative and aggressive capital allocation can achieve great outcomes. You can still take a drawdown and be patient for the correction. Diversification and venturing further up the curve can be sustained.

Long-Term

Long time frames like 20 years can sustain higher risk to reward trade-offs. However, so can sticking with a simple strategy carried out with discipline and consistency. I like the call this stage of the curve Patient Capital. You can stomach large market volatility and cycles and still have enough time to make corrections. Lower liquidity is ok because the cash isn’t needed in the short term. You can still follow a lower-risk strategy yet with 100% allocation to stocks. In this time frame avoid anything that may not keep up with inflation, cash, interest accounts, and bonds. This could be buying property, stock funds, or private equity where patient capital is needed.

Goals will drive the length of time and asset class.

Your goals are key as this will help to determine the length of time and what investments are best suited to achieve the goal. For example, a retirement fund when you are in your 30s is a 25+ year strategy, as opposed to wanting to buy a house in the next 5 years or wanting to pay for your child’s education in the next 18 months. Stability and low risk in the short term are where most investors start on the time horizon curve. As the time horizon expands, you can venture further up looking for higher returns.

Liquidity is another important factor to consider. Tying your capital up in higher risk assets that need a 7–10-year time horizon to play out is not ideal when you need the money in a couple of years.

You can have multiple goals and different investment strategies to suit each one. Many investors, including myself, have different asset allocations for different objectives. Whilst I am an active stock picker, I still take advantage of cash, fixed-interest accounts, real estate, and ETFs. Each plays a different role. All my asset classes have a different time horizon that suits a different objective.

Questions to ask yourself to help know your time horizon:

• What are some of your goals both shorter term and longer term?
• How long do you think each goal would take to achieve?
• How much money do you need to achieve this goal?
• What type of return rate will help you achieve this goal?
• Would a loss on this capital impact your life right now?
• Are you prepared to venture up the risk curve for those time frames?

In Summary…

Here is a brief example of my approach to time horizon considering risk and goals. This is simply suited to my lifestyle, experience, background and what I want to achieve. My number one goal is INDEPENDENCE.

I’m still young so have the power of compounding on a 30+ year horizon. This is not about retiring so later in life (I can retire now) it is about long-term wealth creation and planning (and the odd spot of strategic tax planning and government incentives). So, I have a retirement fund where I dollar cost into the same ETFs with all dividends reinvested. Why? I don’t need to take excessive risks to achieve a great result.

My active investment fund (where I live and breathe) is usually a 10–15-year time horizon. This is where I am 100% allocated into stocks. The goal is to compound my capital at the highest rate of return possible, whilst being mindful of risk. I hold positions for this length of time or unless the thesis breaks. What I do with the compounded capital and gains is either reinvest back into new high conviction ideas or I take it out and allocate it to other asset classes.

Then my shorter-term goals such as ensuring I have cash flow and the capital to sustain my lifestyle and Independence. So, liquidity and access to cash is key. I may hold short-term maturing fixed interest products to help achieve this goal. I don’t risk it because I value my independence to be able to achieve my medium to longer term goals.

There is a little more to the above, however in a nutshell you can see how time horizon and risk tolerance can play its part into achieving different goals.