Investment Time Horizon: Why It Matters
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.
What is an Investment 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:
- You don’t want to outlive your assets. You don’t want to presume you’ll live until 85, plan for your assets to last until then and no longer and end up living into your 90s.
- There are many comforts money can buy as you get older. Don’t forget the grandparent effect. Spoiling your grandkids is so darn fun.
- Average life expectancy has done nothing but increase. US life expectancy has increased an average 1.6 years for men and 1.5 for women every decade since 1950. 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.
How Does Your Time Horizon Affect Your Investment Strategy?
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.
Click here to read Part II: Health & Life Expectancy