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.