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The trouble with time horizons

Posted: 9th February 2015

BARCLAYS_COL 300dpiIn investing – as in life – ‘long term’ can mean different things to different people. Similarly, one’s emotional horizon, although rarely considered at the outset, can sometimes take years off the period of time that an investor stays in the market.

While sensible financial advice extols the value of long-term investing, views vary over what ‘long term’ really means. Similarly, the notion of an investor time horizon remains one of the most misunderstood concepts in finance.

First, let’s look at what the investment horizon is not:

  1. When thinking about your overall portfolio, your time horizon should not be how long you’re prepared to stick with any single investment or manager.
  2. An investment horizon is distinct from your rebalancing horizon: we should all periodically re-balance our portfolio back to our appropriate risk level and make sure the investments are still doing what they are supposed to.
  3. It is not (or rarely) the same as the time to retirement: many investors still have some capacity to invest post retirement.

Put simply, your investment horizon should be determined primarily by when you need the money: i.e., how long do you have before your option to choose when to sell expires?

During our lives, most of us will have interim needs to withdraw capital – either to fund large purchases, or ongoing expenditure after retirement. These investors have finite investment horizons, and the larger or sooner the future withdrawals – unfunded by expected income – the more they reduce the overall time horizon.

For example, someone who is retiring in three years and wishes to purchase an annuity with his entire portfolio has a very definite time horizon of three years. He has little flexibility to choose when to sell and should therefore take very limited risk in the intervening years. On the other hand, an investor who can afford to stay invested after retirement has a long sequence of much smaller withdrawals over the rest of her life. She can afford to take much more risk in the pursuit of higher portfolio values over time.

As a general rule, asking investors to tick a box to specify their investment horizon without considering their need to use the money is counter-productive – it often forces them to state a time horizon that is much shorter than their true goals.

Finally, as mentioned, there is another threshold that we should be aware of – the emotional horizon.  Selling low because you need the money can be resolved by reducing risk over time (to account for your shortening horizon); but many investors sell low even when they still have the option to hold on. In times of stress our emotional horizon shrinks. Good investing requires not just determining our investment time horizon, but also controlling our emotional one.

No matter what stance you take to investing, your capital is still at risk.

Greg Davies - BarclaysGreg Davies

 

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