How long are you going to need your money to last? This seemingly simple question is perhaps the most important thing you will have to consider when planning your finances for retirement. However, calculating a time frame is not as straightforward as you might imagine. We refer to this aspect of time in an investor's portfolio planning as the investing time horizon and is one of the major determining factors when working out the potential cost of your retirement.
It's surprising how many people think their investing time horizon ends the day they retire or at the point they start making regular withdrawals from their portfolio. Your investment time horizon should be defined as the amount of time in which you need your money to last. All too often investors begin shifting their portfolio into a heavily fixed-income-focused strategy as they approach retirement, which is often thought of as ‘conservative’. While some investors believe that this may be a safe approach, it may introduce an unintended risk—potentially running out of money in retirement. Though many think of this approach as conservative, we believe this approach may be less conservative than it seems, as it may not result in the growth you need to reach your financial goals.
Instead, we believe your investment horizon should be based on the amount of time in which your money needs to last. This investing time horizon can be based on your life expectancy or your spouse’s or even longer depending on your goals or if you plan to leave a legacy.
People today are living longer than many expect. Despite breakthroughs in modern medicine, investors often consider their investment time horizons to be about 20 years or maybe less—overlooking the possibility that they could live longer, maybe much longer than average life expectancies. Your investment time horizon can also be expanded well past your life depending on if you plan on leaving money to a spouse or leaving a legacy to family, friend or charitable organizations.
Many people enjoy better nutrition and greater access to exercise facilities than previous generations. We also have the added benefit of medical advances and new healthcare technology. Average life expectancies across the developed world are longer than they used to be. Remember, these are just averages—you should plan to live longer than the average. Factors such as current health and heredity can also cause individual life expectancies to vary.
If you're 65 or younger, you may still have a substantial investment time horizon. This can be longer still if you are in good health, have a younger spouse or have a family history of longevity. So the longer your investment time horizon, the more growth you might require to keep up with all of your cash flow needs. One potential way to increase your long-term portfolio growth is by increasing your equity exposure.
This can be a difficult reality for the risk-averse investor who finds comfort in the idea of a low-volatility portfolio, focused on fixed interest, insurance products or cash savings. Some investors mistakenly believe market volatility is the only type of risk, which couldn’t be further from the truth. Here are some other risks to consider when investing:
Don’t overlook these potential risks, and as the decades pass, you should re-evaluate your long-term goals and personal situation as they may change with time.
In our view, asset allocation is the most important factor in determining your long-term portfolio returns. Asset allocation is your portfolio’s mix of equities, fixed interest and other asset classes. When some investors approach retirement, they often believe that this is the appropriate time to increase their exposure to fixed interest with the goal of experiencing lower volatility. While fixed interest will provide lower volatility, it may also reduce your overall returns.
Considering inflation and cash flow needs, you may need more long-term portfolio growth than you’d originally expected. Volatility can shift investors focus from the long-term to the short-term, as they may make emotional or reactionary trades. These instances are where having a professional to guide you can be helpful. Investing is easier said than done, make sure that you are spreading your risk out across various companies, sectors and countries in an effort to manage your portfolio risk.
Determining your investment time horizon is a crucial part of retirement planning and should not be overlooked or underestimated. When making portfolio strategy decisions, investors should consider their potential investment time horizon, especially if it extends past their own life.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.