Risk & Your Investment Time Horizon
Posted by Gail | Filed under Investing
Time plays a big part in how you choose to invest your money. The longer you have until you will need to use the money – the longer your time horizon – the more time your investment has to even out it’s return, taking care of the volatility risk. But time also gives inflation more to work with as it eats away at the value of your money. The trick is to match your time horizon to the investment you are choosing, always keeping inflation in mind.
Fixed-income investments like GICs have no volatility and the return is guaranteed. You can’t lose your principal and you know exactly what you’ll earn in interest on the day your GIC matures. The “risk” is that the return you earn won’t keep you far enough ahead of inflation to grow your assets in real terms.
The same holds for a bond or mortgage investment that is held to maturity. (If you’re actively trading bonds or mortgages, they behave more like equities, responding to market conditions.) So it doesn’t matter whether you go long or short, you’re guaranteed your return as long as you hold to the end of the term you choose.
Equities – things like stocks, and stock-based mutual funds — are a whole different kettle of fish. They can be very volatile depending on their nature, some offering more price stability and others offering more opportunity for growth. The “risk” with equities is that they may be at a low just when you need the money and must sell them. That’s why they don’t work as short-term investments. They work as long-term investments where you have time to ride out the highs and lows and average out your return.
Less than three years is considered a short-term investment horizon. Three to nine years is considered medium term, and ten or beyond is considered long term. In light of the recent downturn in the markets, some experts are now saying “long term” is closer to 20 years. That may be because people are a little pessimistic about when these markets will be coming back.
Short-term investors – people who plan to buy a house in two or three years, or who know they’ll need their money at a moment’s notice — should avoid putting the majority of their money in investments that are potentially volatile. Choosing fixed-income investments that generate a steady return while offering a higher level of security is a better idea.
Medium-term investors can balance their investment portfolios using both equity and fixed-income alternatives to create an asset mix – a combination of investments – that gives them some safety and some potential for growth.
Long-term investors – people in their twenties, thirties and forties who are saving for retirement — have the luxury of time and can choose an asset mix that is weighted more heavily with equity investments. 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.
Keep in mind that your investment time horizon is always changing. If you’ve socked away $10,000 in an RESP for Junior who is just 2, you won’t need the money for about 16 years, so you could go long-term and chose some stocks or equity-based mutual funds. But as Junior gets closer and closer to graduation day when he’ll be needing the money, you’ll have to sell those long-term investments and move to a investments with a shorter time horizon. By the time your Minime is in Grade 11, you should be into stuff with zero volatility.
Sometimes people confuse themselves by thinking one way and acting another. Here’s what I mean. If you’re investing money inside an RRSP, and that money is for retirement, which is 20 or 30 years down the road, you have a long-term investment horizon. However, if you’re planning to use some of the money in your RRSP to buy a home in couple of years, that pool of money has a short-term horizon and should be kept safe so you’ll have it when you want to use it.
This confusion came to the forefront in a big way when the markets started to slip and side at the end of 2008. People who were looking at retirement in less than 10 years, who hadn’t done an adjustment to their portfolios because they wanted to keep riding the gravy train, found themselves with 30% less just when they could least afford it. The whining and crying started, as if the markets themselves were to blame. This was totally a case of not being up-to-date with your asset mix relative to your changing investment time horizon.
Pssst. If you were working with an advisor who wasn’t telling you to move closer to the safety zone as your time horizon changed, you might want to consider getting a new advisor since s/he wasn’t doing the job!
Next week I’ll do a lil somthin’ on your investment objectives.
February 12, 2009 at 9:58 am
Woohoo…exactly like my blog response yesterday.
Copycat…just kidding. 
But yes, people always have to be aware of purpose & timelines when it comes to their investment strategy. One can never be lazy, and it can be as simple as checking over your portfolio once a year and asking yourself does your current strategy/risk fit with how much time you have left for whatever objective you have. As I said yesterday, if you’re 5 years away from retirement (give or take) then get out of equities (or at least such that you have minimal exposure). Now keep in mind, that just because you’re at 5 years, you hit the brakes and pull out. Market conditions also have to be considered. If you’re going to lose pulling out at 5 years then you may need to wait another year or two to switch strategies. Likewise if the markets are on a roll, you may want to wait a year or two to get some more upside while things are good, but you can’t wait too long! Who would have thought the markets would have crashed 30-40% in a span of a few months…
February 12, 2009 at 10:13 am
Minor note on Erran’s posting re: “if you’re 5 years away from retirement (give or take) then get out of equities (or at least such that you have minimal exposure)” — I think it depends on your investment strategies. If you’re not planning on pulling all your money out the day you turn 65 and/or have invested heavily into dividend paying stocks and expect to live off dividends, you don’t necessarily need to get out of equities entirely when you retire. But Erran’s and Gail’s points are exactly on target — be aware of your horizons at all times.
February 12, 2009 at 10:29 am
Erran, thanks for your comment yesterday (I’m sure you noticed that it did get published – Gail moderates any post with a link in it to make sure we’re not sending her readers off to porno sites!
February 12, 2009 at 10:53 am
Any money that you are going to need in the next five years should be liquid and not in equities.
Revisit your plan once per year and make sure you have 5 years of cash available. Depending on your retirement expenses, you may find you need need to increase or decrease the amount depending on your annual spending plan, health and travel plans. but, if you will need it within 5 years – it should not be in stocks!
February 12, 2009 at 11:47 am
Money Minder:
There is a difference between ‘liquid’ and ‘not in stocks’. If you need in 5 years, it’s ok to put it in GICs. If you need it any time during the upcoming 5 years, then you should choose a secure investment which gives access to your money any time (high interest account…).
February 12, 2009 at 2:33 pm
Money Minder and Marie – good points – I think a combination of high interest accounts and short term investments are good places to keep your money if you’re going to need it in the next 5 years. However I did notice that lately high interest accounts seem to be higher than most GICs! Of course, with savings rates steadily falling, this may change
February 12, 2009 at 3:06 pm
Money money money! What a consuming topic, especially with speculation on future needs. I am glad Gail has laid it all out. Financial advisors can pressure people with their products and (even with good intentions) lead them to a bad-fit.
I never want to move my investments (that whole “buy,hold and prosper” line) and feel frozen by indecision… not that I need to move it right now, but I know I will in the future.
One more thing, about the high-interest savings account, the rates fluctuate there too… kinda frustrating.
February 12, 2009 at 4:53 pm
By liquid, I meant accessible and not invested in volatile investments. Some people like to ladder GICs and Bonds, some people like high interest savingss accounts, CSBs or money market funds…as long is it is not in equities and you can get it if you need it….
February 13, 2009 at 8:21 am
Gail,
Thanks for making a confusing subject understandable. To tell the truth I never really did understand what the risk was for investments. Thanks for putting it in plain English….a timely post!
January 22, 2010 at 6:44 am
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