Know Your Time Horizon
Posted by Gail | Filed under Investing
Your different pools of money will have different time horizons — the length of time during which you will not need to touch the money. An emergency fund has a short-term time horizon. Since you may need it a moment’s notice, it not only needs to be accessible, it also needs to be stable. For that reason, it’s best invested in cash equivalents such as a money market fund, treasury bills or short-term bank deposits. While these types of investments don’t generate heart-pounding returns, they are safe. And since your emergency fund likely represents just a small percentage of your overall pool, a little stability won’t hurt your overall return terribly.
If you’re saving for your daughter’s post-secondary education, whether your child is six or 16 will have an impact on the investments you choose. Your six-year-old has a long-term investment horizon. She won’t need that money for ten years or more. But a 14-year-old is likely to need the money in as little as three or four years. That’s a short-term investment horizon.
The longer you have until you will need to use the money the more time your investment has to even out it’s return. Time horizon isn’t fixed. As you get closer to using the money for the purpose you’ve identified, your time horizon shortens and your investment choices must change. As your six-year-old gets closer to college, the time horizon for the pool of money you’ve set aside for college will first become medium term and then short term. If you don’t respond by changing the investment mix for the pool, you could be deeply shocked when it comes time to use the money. If the markets have changed direction just when you need to move to cash, you could find yourself liquidating at fire sale prices.
Typically, when you read about time horizon, experts say that under three years is considered a short-term investment horizon, three to seven years is considered medium term, and seven or beyond is considered long term.
So once you have decide what the real purposes of your pools of money are, the next step is to go back to your form and assign an investment horizon to each pool.
| How much $$ | Purpose | Time Horizon | Risk Tolerance |
| $2,200 + 150/mo | Emergency fund | short | |
| (Goal: $13 k) | |||
| $15,000 + 250/mo | Retirement | Long: 25+ years | |
| (Goal: $450 k) | |||
| $1,000 + 100/mo | Sammy’s school | Long: 10+ years | |
| (Goal: $30 k) | |||
| $2,000 + 100/mo | Suzi’s school | Medium: 7 years | |
| (Goal: $3 k) | |||
Remember, your time horizon will affect the investments you’ll choose.
Short-term investors should avoid putting the majority of their money in investments where the risk of losing that money is greater. Choosing fixed-income investments that generate a steady return while offering a higher level of security and capital preservation is the ticket. After all, now that you’re pretty close to needing the money you want to make sure it’s there.
Medium-term investors can balance their investment portfolios using both equity and fixed-income alternatives. Equities will give the portfolio exposure to growth while fixed-income will add some stability.
Since equities have historically outperformed all other types of investments over the long term, people with an investment horizon of ten years can benefit from the potentially higher returns equities offer because they have the time to ride out the natural volatility associated with the market. Long-term investors have the luxury of time and can choose to use more equity investments, assuming they have the stomach for them, which we’ll talk about next week.
Next Week: Know Your Risk Tolerance
Last Week: Know Your Purpose
April 13, 2010 at 7:17 am
We are doing ok at setting our time horizons. I really need to figure out how to best invest for the short term. Long term investment is pretty easy to do I think. it’s the short term that is harder for me to come to decisions about.
regards,
Jason
April 13, 2010 at 9:07 am
@ Jason – the key for investing in the short term is too look for something that is pretty darn close to 100% guaranteed or guarnteed fully such as (Canada Savings Bond, GIC, T-Bill, Money Market Fund). Your emphasis for the short-term is on liquidity with emphasis on capital preservation with modest gains.
April 13, 2010 at 9:19 am
This is really important. When we were younger, we were told to put everything into stocks because our time horizon was “so long”. It isn’t, really, if that money is going to be used to buy a house. Our time horizon was actually very short, and I deeply regret the money lost when the market dipped dramatically 1 month before we bought our house.
April 13, 2010 at 9:19 am
I have long term investments in my RRSP’s but I think I tend to be too conservative when it comes to my money. I know that you are supposed to expect “waves” in how well you money is doing but I cringe when I see that my money has lost it’s value. I would consider myself a rookie to investing since my only experience so far is the retirement plan throught my work, in which the financial company sets up the porfolios based on investor profiles. My own RRSP outside of work are in an ING RRSP account.
April 13, 2010 at 9:28 am
Gail touches on something I had not really considered… that we need to move our investments from riskier ventures to safer ventures as our investment horizon shortens. Makes perfect sense!
When I look at the mid-risk mutual funds I purchased 14 years ago, I see that I am just now finally turning a profit! For 12 years they either stayed the same or lost money… In the last year I’ve almost doubled my initial investment. If I had invested for the short term, I would have lost lots of money, however, since I still have 20 + years left before I need that money, I plan on leaving well enough alone. Eventually I will need to move the money to less risky investment options, but for now I’ll let it ride.
April 13, 2010 at 10:00 am
Jason…
Interesting you say that investing for the long term is easy and short term is harder; it’s usually the other way around!
For short term investing, your primary concern is protecting your money. You should only invest in products that will not fluctuate (much). No equities or long bonds or any other investment that suffers from periodic short term fluctuations are acceptable.
You could buy money market investments such as t-bills or banker’s acceptance notes. Short term GICs maturing in less than 18 months or so are also good buys. My clients are often using high yield bank accounts like ING. Money market funds are normally an option but they are not paying well because the rates of return are barely covering their fees.
Hope this helps. Short term investments should be the easiest part of your portfolio. Just remember, protect your money first, go for rates second.
Good luck,
Neil Murphy
Weigh House
April 13, 2010 at 10:44 am
Hmmmm this has been a real eye opener. I mean I know Gail has been saying this for years now but it never sunk in. I guess we have to start working our way backwards and plan our retirement this way, instead of simply forging ahead not knowing where we’re going.
I will sit down with hubby and try to make a plan too…
April 13, 2010 at 11:30 am
The part I find hard is fighting my own greed. I had money invested for both kids for university (in Growth funds) and they were doing so well that I just couldn’t bring myself to move it to safer investments as they got close to finishing high school. Then 2000/2001 came along and they lost money just as they were heading off to school. I felt so bad for them, but if I’d moved them many years earlier, I think they actually would have been worse off (simply because of the great boom of the late 90s), but I’m not recommending anyone else take that chance…I just got lucky that I had the big boom before the fall. In hindsight (ain’t hindsight great?) I wish I’d moved them safer in the late 90s. Lesson learned. Set up a plan and don’t let greed make you change it!
April 13, 2010 at 11:32 am
Woah! That illustration has $600/month being allocated to savings. That’s a lot of dough for our modest income family! My husband and I are putting away $300/month every month (200 for long term 100 for short term/emergency) and a bit more on some other months (when we can). We don’t have cable TV or car payments or eat out… I am no fashionista and we don’t drink or smoke.
I thought we were doing “okay” but the retirement calculators say we are falling WAY short of what we need to be putting away to ever be able to retire. Hopefully there is still time for the long term stuff to turn around in our favour (we are now 39 and 38 years old). As far as our boys going to college, they will be asked to do what we did: apply for grants and scholarships, work through college and take out loans as a last resort. College is a smart idea, but it’s still a luxury, not a right. I will do my best to instill a proper work ethic and pride in a job well done and worth doing, but I really don’t believe it’s my responsibility to pay for higher learning especially at the expense of my own security… my dad told me “you have your whole life ahead of you to make your own way, I only have this left” (that was his reasoning for leaving his estate to his wife instead of his daughters, but the lesson still applies here).
It’s a good time to really review our financial priorities and see if we are spending towards a life that is honouring those priorities.
April 13, 2010 at 12:21 pm
I think the hardest time horizon to invest for is “medium” term. With short term you’ve got the easy answer of low-risk bonds because their return is (or almost is) guaranteed; with long term investments, almost anything (that’s not an scam) goes risk-wise. But finding the middle ground for medium-term investments seems more difficult to me…
April 13, 2010 at 12:22 pm
I think that investing in higher learning for your children will come back to you tenfold when they get great paying jobs and look after you in your old age. This is what my parents did.
April 13, 2010 at 12:33 pm
@ Pol – I also paid my way through university. But one thing to remember is that education costs are rising way beyond the rate of inflation. It’s possible (probable?) that kids in 2020 will simply not be able to find work that pays their wages, which burdens them with huge student loans. Particularly if they’re in competition with older, experienced workers who are willing to do jobs that in the past they wouldn’t (a la now). In fact they may get so discouraged they don’t even attempt it. Something to consider, at least.
@ Tracey – yes that’s a good story I’ll have to remember when my son turns 13. He’s 2.5 now and is 80% in equities, 20% in bonds. At 13 I’m moving him up to 40% bonds, and then each year another 20% until he’s 16 and all in bonds. Unless I get greedy on his behalf.
April 13, 2010 at 12:41 pm
Quite soon after we paid out our debt and started re-shaping our finances we discovered this concept of a time horizon. Never thought in either short term or long term but learned you have to. We never saved anything for emergencies whilst we were paying down debt so of course we got hit with an emergency right after we made our last debt payment and had to go back into debt to get out of the emergency. We started an emergency fund right after this but I believe emergencies travel in packs like wolves so our savings got eaten up again by a couple of other emergencies. I think while building an emergency fund you have to hope for good luck – especially good health. Our problem was that one of the emergencies was really a short term problem while the other was a big long term problem. We used the emergency fund for the short term problem so ended up with little left over for the long term problem.
Today we acutally have 2 kinds of emergency funds. One is for “little” emergencies that surprise us and that our budget doesn’t reach far enough to cover. It gets used and replenished quite regularly. The other is what we call Back-up. We are aiming for at least 6 months worth of expenses in this fund and it is money that will only get used if we have a break in earning. This money earns but not that much but it is fully accessible. We haven’t had to touch it yet. We also have a savings fund which is for way down the road – retirement – and it never gets touched. It is invested for the long haul.
April 13, 2010 at 12:48 pm
I am putting money into RESPs for both my kids, but will beg to differ on the wages not increasing while tuition does. When I finished university almost 20 years ago, I started out at $23K or so for my first job. Young graduates nowadays are starting in much higher income brackets, closer to where I started when I re-graduated 10 years later.
If my kids choose a field that doesn’t pay as high as a computer science or engineering field for example, then I’m expecting their tuition costs will be geared to what they should expect as their initial wage. If my child does a 2 year program and expects to start at $60K, then good luck with that, but my RESP contributions are about all I can provide, so expect to pay back some student loan money with that whopping starter salary (while likely living in my basement or with roomates for the first year or so).
Good money management skills taught to them should mean that I don’t have to throw all my saving/investment money into their education. I don’t expect my kids to take care of me at all…that’s what they’ll do when they have their own families I hope. If I didn’t figure out along the way to “old” how to take care of myself and not relying on my kids to take care of me, then I failed myself and ultimately them as well.
April 13, 2010 at 1:32 pm
So true! I found out that my mother, in her 60s, was 75% invested in stocks a few years back and she lost a ton of money. She panicked and took most of her money out and put it into bonds, so she pretty much missed last year’s gains. I’m 75% invested in stocks and I’m only 30. That’s also my risk tolerance level and I’m fine with it. But given my mom’s initial desire to retire in her 60s, that level of market exposure made no sense. She’s still struggling to find that balance for her, and has pretty much given up her plans of ever retiring, which is sad.
As for me, most of my goals are either short term or long term, nothing really medium here! So for my short term goals I put my funds in a money market account, and long-term in mutual funds. My peace of mind at night is paramount to our family!!
April 13, 2010 at 2:15 pm
@ Michelle – I meant that the cost of tuition has far exceeded what a student earns during the education, not that getting a degree doesn’t improve one’s salary usually. Just in the future, it’s even more likely that getting a degree will be table-stakes, and not anything special. That makes it even worse, actually.
In the past decade, tuition has increased each year by an average of 4.4 per cent while inflation, as measured by the Consumer Price Index, has risen at an annual rate of 2.3 per cent. (parentcentral. ca) In otherwords, it’s being outpaced year after year after year. The average tuition fee doesn’t include ancillary fees for athletics, health services or student associations. On average, Canadian undergrads paid $695 for such fees in 2008-2009, up from $673.
Michelle, when you graduated from University in 1990, do you remember what one full year of tuition cost? For students now in Ontario, it’s $4,724 up from last year’s 4558. When I started at YorkU in 1994, it was $2800. when I graduated, $4000. That extra $1200 was really hard to earn from May – August.
I do believe that one should plan for one’s own retirement as well. I am not planning on funding my son’s masters’ or phd degrees, for instance. But one degree? Yes, I am doing the best I can for that.
April 13, 2010 at 2:36 pm
@Ronnie…sorry to hear about your mom…unfortunately for our mothers, investments weren’t part of the “lessons girls needed to learn”. Thank goodness, in our generation and those to follow, we have the opportunity to learn about how to invest our money for the future…my mother will be living off CPP and OAP and what little other money she can possibly bring in. I will do what I can to help her where I can but, I too am not willing to risk my security to help her…she has been taking care of herself, good or bad for years and will continue to do so…all I can do is help out where I can.
Gail…another great blog as usual
)
April 13, 2010 at 2:49 pm
@Geoff: Ah, sorry about that…I re-read and got the gist of your comments this time. I thought you were saying that getting a loan nowadays to repay later would be astronomical in comparison to “back in my day”. A loan sucks either way, but the salaries of today’s grads has doubled or tripled what I started out with, so if the loan is subsequently double/triple what I had to take out, then it’s all price-pointed the same is what I meant. It’s all relative…a $13K loan with a starting salary of $23K 20 years ago is the same to me as a $26K loan with a $46K salary in today’s dollars.
I think it’s becoming more acceptable for grads to stay in their parent’s homes for a year or two as well…I had to leave home to get a job, but it would’ve also been widely frowned upon to say I was living with my parents when I was 22 as well. I guess I say this with tongue in cheek, as I am reading stories of many 40 year old re-bounders these days!
As for course/tuition fees, I vaguely remember a Summer course costing around $700/course plus books, so even 20 years ago it wasn’t cheap. Multiply $700X5 courses for a full course load rounds to about $3500/semister 20 years ago, $7800 in today’s course calendar per semester. Don’t ask me what the tuition increase rate is for the difference, but if you say 4.4% I’ll believe you.
April 13, 2010 at 3:01 pm
@ Michelle – no worries. That must have been an expensive course. According to statscan (it’s my day off, what can I say) the average fulltime tuition cost was $1464 in 1990/91. I agree that in terms of carrying costs your two loan examples are the same, but I’d rather have a $13K loan than a $26K loan. It’s not like salaries increased in a vacuum – rent, housing costs, food, etc have increased as well.
April 13, 2010 at 4:32 pm
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April 13, 2010 at 8:11 pm
interesting debate on funding education…I will say that I worked during the school year and summers/holidays as well as going after scholarships and work study opportunities. given that I was 100% self reliant for every single expense (not just tuition) from 17 years old until I grad’d early (3 1/2 years for a bach degree, with honours) I still had close to 30K in student loans to pay off. Min wage while at school was terribly low! It took 10 years of payments to rid myself of that student loan monkey and considering grad in mid 90’s I did not earn much at all…1400 a month before taxes. We will do all we can to assist our child get higher education without wiping out his having to shoulder some of the expenses (want him to learn something about life as well as book smarts)
April 13, 2010 at 8:39 pm
Ah, the debate over kid’s education! I got my degree in the 1990’s….I was lucky enough to live at home free of charge (thanks m&d!)…I figured I spent $30k to $35k for the degree. I worked summer or co-op jobs (thank you U of R for requiring co-op in my B. A. Sc.!)…or if I was short, I could borrow interest free from m&d (but had to pay back)….think I borrowed $1500 that way.
My husband — poor guy. His parents moved to a different province 1 year into the degree…..and he didn’t qualify for student loans, as his dad made too much. Too bad the gov’t didn’t consider that his m&d didn’t give him any money at all for his degree. He figures with rent his degree cost about $100k. At one point he was working 3 jobs + school….times where he was earning 450/month with rent at 300. Near the end of the degree, he asked the bank for a loan — instead, they upped his limit on VISA…….at that point VISA had just introduced VISA cheques, so he ended up paying his rent that way a couple of times. Let’s just say he learned A LOT about time management, and priorities.
FF to now……I’m at home, degree on the wall. *Glad* to have it even though I’m not using it. He is working, not in his degree field, but due to the degree has moved up in the company such that his base salary is just about 3x his staring salary. He’s glad to have the degree, even though he’s not using it. Well…..technically we’re not using it, as neither of us are working as engineers, but parts of the knowledge learned are used daily.
As for our kid — we’ll offer the 0% loan to him. But he needs to save for the first year first….and pay us off eventually. He better qualify for some sort of scholarship — those are really really handy!
April 14, 2010 at 1:02 am
Interesting discussion. I don’t know if any of you have checked out any of those tuition calculators, but the ones I tried told me that my 1 year old son can expect to pay somewhere in the neighbourhood of $130K for an undergrad degree (that’s four years full-time tuition and books, no living expenses) in 18 years. If we don’t take full advantage of the RESP program, I doubt he will even have the choice whether or not he would like to go to university.
As for all the speculation that such increased student debt will be offset by higher salaries, does anyone remember the rather shocking news item that came out last year about how little our incomes have increased in 25 years? Incomes have stagnated across Canada, while living costs have escalated. I don’t think we can assume that salaries will even come close to easing the burden of a $130k student debt load in 18 years’ time.
I don’t know about the rest of you, but after seven years of post-secondary in the 90s, I owed the national student debt average: $24k. I’d be in a very different place right now financially if I had not had that debtload to deal with as I was starting out my career.
I also went to York U, Geoff, in ‘93 and watched my tuition almost double in four years. I had a scholarship and a good summer job, so I was able to finish my degree with almost no debt (and that was living away from home – a whole other kettle of fish – accessibility of post-secondary education to rural kids who can’t get around those living costs), but the college diploma program I started the following year is what racked up my debt. It still boggles my mind that tuition went up that much in that amount of time: that I paid more in tuition for a college diploma than I did for a university honours degree with an exchange year and extra courses.
My younger brother started his degree at U of T seven years after I began mine and his tuition was three times what my first year tuition was. Geoff is absolutely right in saying that tuition increases are way beyond the pace of income raises.
It worries me. Society benefits when people can access good schools and higher level learning. If we let education get too costly, we’ll pay for it in the future with way less brain power and qualified professionals. Education is a social investment, as well as a financial one.
April 14, 2010 at 7:29 am
A story about tuition costs and working through school.
I paid my own way through school – worked part time and lived in a different city then my parents — it took me 7 years to complete my undergrad because I could never do more than 3 classes a term (minimum to count as full-time) and work 30 hours a week to pay for it.
My sister (who is 4 years younger) lived at home and got grants/scholarships to pay for the tuition/school costs
While I gave up in my last year and took out a student loan to complete school (I was tired of it taking so long) my sister didn’t have any debt.
We basically started working at the same time so are at about the same place career wise and salary level wise (I make more but that has more to do with the field I am in).
There is a reason the average time to complete a 4 year university degree is now around 5-6 years
April 14, 2010 at 9:22 pm
I’m currently completing my BSc. this year at the University of Alberta, and my tuition + fees + books for the past 4 years is probably near $30,000. Sharing an apartment with roommates all 4 of those years costs an additional $24,000. Groceries? Probably around $5000, modest estimate. I also have a cellphone, which probably cost another $2000 over 4 years.
So what are we at? $60,000+?
I just filed my taxes this year, and guess what I made in 2009: $10,000.
Yeah.
I’ve managed to stay afloat virtually debt-free thanks to grants & scholarships (my parents have not provided a penny towards my education), plus tutoring & babysitting, but come on.
And this amazing salary for new graduates you speak of, where do I find that? My boyfriend just interviewed for a job with his BSc. and they offered him $38,000 (he almost laughed, but they were serious. wtf??). Another friend of mine was full-honors chemistry and his entering salary was $42,000.
It’s sucky out there. There are no magical high-paying starting jobs unless you’re an engineer or a pharmacist.
I’m going on to my PhD… and I’m worried about graduating with that also, to be honest.
April 20, 2010 at 7:07 am
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