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.

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

People invest for one reason: to make more money. But what are you making more money for? If you’re looking at retirement 20, 30 or 40 years down the road, that’s very different than trying to make more money to buy a house, put your kids through school, or go on a much longed for family trip.

A while back I wrote about thinking of your money in four piles: cash flow, emergency, planned spending and long-term saving. It might also be useful to break your investment objectives down – and your investment dollars into separate pools — to better see what it is you’re trying to accomplish. Pools could better help you match the right types of investments with your goals, keeping in mind your risk tolerance and time horizon.

Here’s an example of what I mean. There was a time when the only thing an RRSP was used for was retirement planning. “Never touch this money,” the experts expounded. “An RRSP is a long-term investment,” the specialists declared.

In reality, people use their RRSPs for a multitude of purposes. Some people dip in when they quit their jobs to return to school or train for a new career. Couples with families dip in to provide income while one or the other is at home with their tots. People thrown into periods of unemployment because of declines in business and layoffs dip in to make ends meet. Even the government got into the swing, introducing two perfectly legal ways to dip in without tax consequence: to buy a home or to fund your education.

For each pool of money you create for investment, whether inside or outside an RRSP, you must know your purpose – your final goal – before you try to decide what investment vehicles to opt for. If in fact you have a long-term investment horizon – you’re not planning to use the money until you metamorphose, and you’re a mere caterpillar now – you’ll be fine buying stocks and equity-based mutual funds. But if you’re using your savings pool to build a cocoon in another two to three years, you don’t have a long-term investment horizon. It doesn’t matter that you’re using an RRSP as your savings vehicle. If you’re planning to pull some or all the money out for a downpayment, you have a short-term horizon and shouldn’t be in equities.

No matter how long-term your home ownership plan starts off as, at some point before you go house hunting you have to adjust to a medium and then a short-term investment horizon. That means moving from alternatives like stocks to medium-term bonds, then short-term deposits and, eventually, cash.

One of the toughest parts of managing an investment portfolio is keeping track of what money is for which purpose, so you can continue to adjust your asset mix as your time horizons change. Whether you pool all the money together in a single investment plan, or you keep the pools separate, it’s a good idea to put a timeline on the front of your file folder as a reminder about remixing your assets as your time horizon shortens. So if you’re planning to lay some eggs six or seven years down the road, you might remix your portfolio at the five-year mark, and again at the three year mark. A good advisor can help you do this, but you must be up-front about how you plan to use the money.

Finally, while it’s fine to use your investment dollars for any purpose you wish — it’s your money, you get to decide how to spend it — it’s important not to sacrifice your long-term goals for your short-term dreams. If you’re saving for a home, instead of putting your whole RRSP contribution into your “Home ownership RRSP” this year, divide it equally between home ownership and retirement. Yes, it will take a little longer to get into your dream home. But when you do, you won’t be behind the eight ball in terms of retirement planning. Striking the right balance in saving is just as important as in life. A little into each pot will serve you well.

I’ve had quite a few requests recently for sample Budget Binder pages. This is an example of something that already exists on the site and you just have to search for it.