What is an investment horizon?
The number one question to ask before making any investment. A guest contribution by Catherine Emerson from Kernel Wealth
“Where are you going to be in 5 years’ time?” We are often asked this question in interviews, goal setting workshops or development plans.
The fact is, you can have a plan, but you know that the world is an uncertain place. While some things are in your control, many are not. This shouldn’t stop you having a plan; if you identify the factors of success, put targets in place and stick to them, you’re more likely to succeed.
The same applies to investing and the seeking of income and growth, aka your “investment return”.
The number one question you need to consider with any investment is:
When will you need the money back?
Financial gurus often like to phrase this as “what is your investment horizon?” Understandably, this question may not mean a lot to you – a bit like how long is a piece of string? It could be simplified too: in the short-term, medium term or long term, or even more simply “soon or later”.
But it’s important to answer, so let’s break it down.
If you are saving for a particular goal – a holiday, a car, a house deposit – you probably have a timeframe in mind.
Let’s consider Suzie, a regular investor wanting to buy a house, ideally within the next five years.
What if any number of things happened that meant Suzie could wait an extra year or two? Perhaps over the year she had a decent pay rise and did the sums to realise that by waiting (and investing) for a further 18 months, she would be able to buy in a better area.
Suzie’s five-year time frame is now more likely a seven-year time frame – a trade-off she is quite comfortable with if it means having a better house. Had we asked Suzie on day one, however, if she wanted to buy a house in five years or seven years, she most likely would have said five.
None of us can predict the future.
Things are always going to happen that will impact our time frame. What matters is how comfortable you are adapting to the change and being flexible on when you need access to your money. This means that your investment horizon can be determined with the following:
Investment horizon = ideal time + flexible time.
Why is this important?
Knowing when you need to have access to your money helps you determine how conservative or aggressive you can invest. Funds that you don’t need to touch for 5 years would not be sitting in cash. Funds that you need in 12 months, however, are likely to be.
So, before you invest note down your answers to these three questions;
- When do I need to access/spend the money for [insert goal]? (1)
- Am I flexible on this time frame?
- If yes, by how many extra months/years? (2)
Then, as shown above, sum together (1) + (2) and you’ll know your investment horizon. Once you know how long you will be investing for, then you can start to consider other aspects of investing.