When the markets start acting crazy, remembering your investment
horizon puts everything back into perspective. Fears in Europe, the
economy, unemployment, and a few hundred other data sets all add to the
daily swings of the market. But you can lower your risk to these issues
by building your portfolio around a strict investment time horizon.
So are we heading for a repeat of last year? Or are the recent
headlines another gut check for every investor out there? More
importantly, should it really matter?
All that noise breeds a shortsighted view of your money. What is
different today that affects your investment risk? The answer should be “Nothing” if your portfolio is built around your investment horizon.
Focus On The Plan
When you invest, there’s a plan of attack. It should be based on your
goals over the next few months, years, and decades. Your plan stretches
from tomorrow till your final retirement years. Breaking those goals
down – from groceries next week to college for the kids, then your
retirement and beyond – gives you an investment time horizon. This
timeline tells you how long you’ll hold each investment.
Knowing this, you can manage risk easier by matching your portfolio
against your time horizon. As you look across your timeline, the
investments should go from low risk to higher risk the further you go
out.
A basic investment horizon can be broken down into three buckets:
short, medium, and long-term. As the years go on, each time horizon
naturally shortens. Here’s the basic investment guidelines for each
bucket:
- The next 3 years – You shouldn’t take on risk with these short-term investments. Stick with savings accounts, money market accounts, and CDs.
- The next 4 - 10 years – You can take on risk, but not too much risk in the medium term. Stick to a conservative mix of bonds and stocks for this investment horizon.
- Beyond 10 years – You can take more risk over the long-term. Stocks can make up a bulk of these investments with a small portion in bonds.
Understanding your investment time horizon lets you overlook the
short-term risks of the market. The next time the S&P 500 drops 20%
(and your knee jerk reaction is to sell) you can rest assured that your
short-term investments are protected, while your mid to long-term
allocation can handle the change. When you put it altogether, it means
less day-to-day worry.
Your Investment Horizon Will Change
Every year, you’re another year older and your investment horizon changes. Life changes. That’s why you do regular rebalancing and annual reviews.
Each rebalance automatically adjusts your portfolio to the risks of
time. As your timeline shortens those investments become less risky
because your portfolio slowly moves from growth to preservation of
wealth.
Take Advantage of the Drops
For those in the early stages of their timeline or who can stomach
more risk, your cash holdings have a dual purpose. It’s insurance for
when things go south but it’s a growth engine too. Having cash on hand
is a comforting thing. But when you have a job, income, and the bills
are paid that cash has better uses.
When the market falls again (and it will) in the short-term, take
advantage of it. Put that cash to good use. You take advantage of
products when they go on sale. Why wouldn’t you do it with stocks and
bonds? Use that buying opportunity to boost returns and compound your
long-term growth. Until then, focus on your time horizon.
Source: http://novelinvestor.com/investing/remember-your-investment-horizon
