When it comes to investing there are all sorts of approaches and strategies. Some of us invest for the long term, and some want to profit from short-term movements. There are even some of us who look at a medium-term investment horizon. It all depends on your personal goals, and when you need your money. As well as your investor profile. The period during which you hold your investments is usually referred to as the investment horizon.
Types of investment horizon
There are three main types of investment horizons, short-term, medium-term, and long-term. You can apply one of these, or you can build a portfolio with multiple assets to try and capture different time horizons.
Short-term investment horizon
The short-term investment horizon is often characterized by sudden and rapid price fluctuations that investors try to profit from. Usually, the period can be less than one year, and it can go up to three years.
Although short-term horizon encompasses traders, there are also investors who allocate a part of their portfolio to short-term horizon investments. Most notably treasury bills, tend to be a great option to put some of your money in the short-term. They are essentially risk-free and allow you to earn additional interest on the money you do not want to invest right away.
Medium-term investment horizon
Medium-term investors are usually those of us who are expecting to need the money soon. For that reason, it is important to keep a part of your portfolio allocated to low-risk holdings. You can take some risks in the medium-term, but since you might need the money you don’t want to take too many risks.
Long-term investment horizon
A long-term investment horizon and mindset is perhaps the greatest attribute you can have as an investor. There are several benefits, and it allows you to structure your investments in a totally different way. Since you do not have any time constraints, you can take more risks. This directly affects your risk tolerance and risk capacity. Therefore, you can invest, and allocate your capital freely. With a long-term horizon, you can generate outstanding returns, simply by buying and holding.
How to determine your investment horizon?
When do you need the money back?
The key factor when determining your investment horizon is when you will need that money back. If you are investing for retirement you can have a longer time horizon. On the other hand, if you need those funds sometime in the future, you might have to adapt your investment strategy. If you have a big expense coming up, like buying a house, or a car, or even sending your kids to college, you might want to protect your principal.
Determine when exactly you will need the money, and try to invest according to that. For example, if your investment horizon is just five years, it would be wise to take as little risk as possible. As you don’t want to risk money that you might need further ahead.
How old are you?
Another important factor to determine your investment horizon is age. The older you get the more you should worry about capital preservation. When we are younger we can take increasingly more risks, as the loss of capital is not as impactful as when we are older. Therefore, we pursue a capital accumulation strategy. As opposed to older individuals who prefer capital preservation investments.
What are your investment goals?
This is another important question to address. Some of us have a higher risk tolerance, and for that reason are more predisposed to take on more risk. There are also some investors that tend to be conservative, and defensive towards their investments. For that reason, they should choose safer, and more reliable investment vehicles.
Trading vs. investing
One of the key differences between investing and trading is the time horizon. Traders are usually short-term-oriented and will try to profit from short-term price fluctuations. Investors on the other end, tend to have a longer investment horizon.
There is no right or wrong in investing or trading. Either one of us chooses the strategy, and approach that works better. You can make money both in the short-term, and long-term. However, there are some key aspects to keep in mind, when you determine your investment horizon.
Long-term investment horizon benefits
Being a long-term investor has a few benefits. Perhaps the most important is that mistakes can often be corrected with time. Have you heard the expression “time fixes everything”? Well in the market it does not always apply. As a long-term investor, you can make far more mistakes than someone with a short-term investment time horizon.
Mistakes can be corrected
For instance, if you bought an overvalued stock, the price might decline in the short term. This is one of the most common investing mistakes. However, as long as the company continues its growth projections, its price can eventually recover in the long term. When you invest for the long term, mistakes are not as costly compared with short-term investment horizons. This is one of the best advantages of the long-term investment horizon.
When you invest for the long-term you significantly reduce the overall risk of your portfolio. The market always goes higher over a long period of time. As opposed to short-term investments that are highly dependent on market sentiment. In the long term, your investment risks are greatly reduced.
Greater compounding effect
Another great important aspect is that as a long-term investor your ability to compound your investments is greater than a short-term oriented trader or investor. The ability to compound your investment portfolio will be directly related to your investment horizon. The larger the investment horizon, the greater the compounding effect will be.
Long-term investment horizon disadvantages
Stock prices may fall
One of the most common risks is that the price might decline in the short term. This is perhaps the greatest risk when it comes to long-term investing. This does not mean that your investment thesis was flawed. Price fluctuations in the short-term are to be expected, and although it can signal that you made a mistake, over the long-term it can also be meaningless.
Final conclusions on the investment horizon
It is important to define your investment horizon and build your portfolio accordingly. You can also divide part of your portfolio for different time horizons, and this might be perhaps the best solution. This way you can capture the returns in the short-term, medium-term, and long-term. When you invest there are always risks to be aware of. The longer your investment horizon, the more you will be able to reduce those risks.