Investing/Investment Horizon

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Investment Horizon

Your investment horizon should drive your investment strategy, your tolerance for risk, and your performance expectations. Depending on the purpose of the assets, horizon is the amount of time until you need income from the assets or you need the principal.

Sample Horizons

Investment horizons are time that vary by circumstance, goals, and needs. For example:

  • You are 35 years old and you plan to work to age 65 (current horizon is 30 years)
  • You are accumulating a college fund for your ten year old (current horizon is 8 years)
  • You are accumulating assets to buy a second home (current horizon is 5 years)
  • You and your spouse are 65, retired, and in good health (current horizon is 30 years) 

Risk Tolerance

Your investment horizon has a major impact on your tolerance for risk. For example, the 35 year old investor should have a high tolerance for risk because he has lot of years to recover losses. Risk tolerance is much lower if you are saving for college or the purchase of a second home. You need a specific amount of money in a specific amount of time. You cannot afford setbacks. You have to be more conservative.

Time

Your tolerance for risk should decline as your investment horizon gets shorter. The best examples is pre-retirees. You have saved and invested for years to accumulate enough assets to retire at the end of 2014. However, there is stock market crash in 2014 that wipes out 35% of your assets. It will take years to recover the losses. You may have to defer your retirement or take a part-time job.

How do you mitigate this risk? You reduce your exposure to stocks as your investment horizon approaches your retirement date. You may want to invest 100% of your assets in a money market fund to lock in a specfic asset amount on your retirement date.

Ticking Time Bomb

A high percentage of people would like to retire and roll CDs, but that is not possible during periods of extremely low interest rates. The problem is compounded by the rising longevity of healthier Americans. A healthy couple, age 65, has reasonable odds of living into their 90s. The day they retire their investment horizon is another 30 years. They will have to take more investment risk than their parents to avoid running out of money late in life.

Paladin says.....

Rational investors calculate their investment horizons and use the information to determine their tolerance for risk. In general, risk is your willingness to take losses to earn higher rates of return. Do not be deceived by advisors who claim they can produce high returns for low risk. High returns for low risk do not exist. 

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