One of the biggest mistakes investors can make is underestimating their investment time horizon—or having a fuzzy or ill-defined one. It can lead to major errors that may not be evident immediately. Often these errors stem not from mistakenly having too long of an investment time horizon, but too short.
A big risk investors often forget about—one that is particularly key when thinking about time horizon—is opportunity cost: the risk of giving up returns you would have otherwise gotten. What’s more, making up for lost opportunity can be very difficult. Investors may simply have to swallow a lower projected cash flow, lower expected returns, etc.
These are all tough realities to deal with—and you’re likelier to avoid them if you don’t underestimate your time horizon.
Your investment time horizon is how long you need your assets to work toward your objectives. For most investors, this is their entire life, and often accounts for their spouse’s life too.
When considering your time horizon, you want to err a bit on the longer side for a few reasons:
Generally, the longer the investment time horizon, the more a bigger allocation of equities likely becomes appropriate in your benchmark. This isn’t to say time horizon is the only deciding factor, but it must be considered alongside return expectations, cash flow needs and other factors.
Many investors think this way: “I’m 55. I plan to retire at 65. That means I have a 20-year investment time horizon.” This is a harmful way of thinking about investing that potentially cuts you off at the knees, especially as average life expectancy continues to increase.
You want to err a bit on the longer side for a few reasons. You don’t want to presume you’ll live until 85, plan for your assets to last that long, and then end up living into your 90s. Further, there are many comforts money can buy as you age.
The chart below shows basic US life expectancy, produced by IRS actuaries. The x-axis shows current age, and the y-axis shows average life expectancy.
So if you’re 30, average life expectancy is another approximately 48 years (i.e., 78 years old). If you’re 70, average life expectancy is another approximately 14 years (i.e., 84).
If your grandparents died in their 80s and your parents are alive in their 90s, odds are good you’ll live at least that long or longer. Then, consider your own health—perhaps high cholesterol runs in your family, but you diet and exercise and keep it under control. Your better health should, theoretically, add to your longevity.
In the 1850s, average life expectancy in America was around 40 years, now it has almost doubled. Average life expectancy has done nothing but increase. Here are a couple reasons why:
If you’re 50 now, for example, and your median life expectancy (according to the IRS) is another nearly 36 years, what are the odds, 30 years later, life expectancy has extended still more? Probably pretty good.
Generally, the longer the time horizon, the more a bigger allocation of equities likely becomes appropriate in your benchmark. This isn’t to say time horizon is the only deciding factor. That would be akin to saying age is the only factor. But it is key. It must be considered alongside and in concert with return expectations, cash flow needs and other factors. But a longer time horizon means investors have more time to grow beyond near-term equity volatility.