What is Time Horizon
Time horizon is the length of time over which an investment is made or held before it is liquidated. Time horizons can range from seconds in the case of a day trader, all the way up to decades for a buy-and-hold investor or an individual who is investing in a retirement plan. Investment time horizons are determined more by an investor's goals for the funds rather than the mechanism itself.
Understanding Risk And Time Horizon
BREAKING DOWN Time Horizon
Knowing the preferred time horizon is extremely important when it comes to choosing types of investments and an overall asset allocation for a particular portfolio. Longer-term investments can often afford to be more aggressive, as short-term losses can be offset by long-term gains.
For example, most advisors would recommend that the asset allocation of a portfolio for a 30-year-old investor be more heavily weighted in equities than that of someone who is close to retirement age. Age is not the only determinant of time horizon. A 30-year-old investor who wants to save money for a down payment on a house in one year would be investing with a one-year time horizon, even though his retirement is years away. Given the short time frame, it would be prudent to invest more conservatively, because there is little time to make up for any losses.
Describing the Time Horizon
Generally, short-term investments are considered to have a time horizon of less than three years, while long-term investments are more often designed to be held for 10 or more years. A person may have multiple investments in place to account for different financial goals that result in various time horizons.
Time horizons are most commonly expressed in years. For example, if a 40-year-old person is considering retiring at age 65, the time horizon for retirement planning would be 25 years. Most advisors would recommend a more aggressive portfolio at the beginning of an investment with a time horizon of this length, as it is generally considered long-term investing. As the person approaches age 65, the time horizon shortens, leading many to advise shifts towards a more conservative portfolio.
Time Horizons and Target Date Funds
Target date, or lifecycle, retirement funds are managed based on a predetermined retirement date that functions as the basis for the time horizon that determines asset allocations. As the target date approaches, the fund is automatically reallocated to become more conservative as the time horizon shortens, with some ultimately converting to income funds on reaching the target date.