Beginner investors entering the stock market inevitably encounter new terminology. A precise understanding of it allows one to quickly grasp the principles of investing, learn to conduct all necessary calculations accurately. In general, for a novice investor to start making informed decisions, it is sufficient to master a fairly limited set of key concepts, which includes the investment horizon.
In this article you will learn:
- The investment horizon, the period within which investment goals are achieved, is influenced by factors such as target amount, initial investment capital, and acceptable risk levels.
- Asset selection plays a crucial role in determining the investment horizon, with higher-yield assets typically shortening the horizon while also increasing risk.
- Experienced investors structure their portfolios based on the investment horizon.
What is the Investment Horizon?
The concept of the investment horizon is multifaceted. Often authors of publications and books on investing use it in various contexts. It is considered a time interval:
- Required to achieve the investment goal
- During which an investor holds an open market position
- Over which the user plans to invest funds.
Overall, all these viewpoints are just specific cases of the general definition of the investment horizon. It can be formulated as follows:
The investment horizon is the period during which an investor plans to allocate funds to various projects and assets, aiming to achieve their set goals through the profit generated. The concept of “investment allocation” in this case includes both the initial investment capital and additional contributions, as well as reinvestment of profits.
The investment horizon is one of the fundamental concepts for any investor. It must be defined (specified) in the personal investment plan.
How to Determine the Investment Horizon?
There are two approaches to planning the investment horizon:
In the first case, the goal is formulated as precisely as possible, indicating the amount to be received and the timeframe for its achievement. This approach is most suitable for novice investors because it allows them to choose an investment strategy and determine the set of assets in the future.
The investment planning option under this approach looks as follows:
- Goal formulation. It includes calculating the target amount and determining the investment horizon. The goal is set as specifically as possible, for example, “to accumulate 1 million dollars for a child’s education within 5 years.”
- At this stage, an investment or risk profile is created, determining the risk appetite, its acceptable level, and, accordingly, choosing an investment strategy.
- Asset selection to achieve the goal within the specified investment horizon.
The calculative method of planning the investment horizon is used by experienced investors who can not only formulate the investment goal, but also correctly take into account important factors affecting its achievement:
- Initial size of the investment capital.
- Opportunities and frequency of regular contributions, including reinvestment.
- Acceptable risk level.
- Return and volatility of investment instruments, including those traded on various markets.
- Time required to manage investments.
In this case, the stages of creating a personal investment plan are slightly modified:
- Formulate the financial goal of the investments (the amount the investor wishes to receive in the end).
- Determine the initial capital and amounts of regular contributions.
- Select assets for investment, forecast expected returns.
- Calculate the investment horizon.
In general, both algorithms do not contradict each other and can be combined. In this case, when setting the initial goal, the upper limit of the investment horizon is determined, and its boundaries are adjusted after selecting assets and calculating the expected return.
What Determines the Investment Horizon?
For novice investors, it is essential to understand the factors influencing the investment horizon – the period within which the investment goal can be achieved. These factors include:
- Target amount – the overall result the investor wishes to obtain from investing their capital. As this amount increases, the investment horizon needs to be extended.
- Initial investment capital and additional contributions. The more funds the investor invests, the easier it is to achieve the desired result. Therefore, increasing the investment capital and regular additional investments reduce the investment horizon.
- Acceptable risk level for the investor. The higher it is, the more volatile assets can be used for investment, thereby reducing the time to achieve the investment goal. However, if the acceptable risk level is exceeded, it may be necessary to close open positions at a loss. Compensating for this loss may significantly delay reaching the desired final result (increase the investment horizon).
The choice of assets has the most significant impact on the investment horizon. Their profitability is directly related to the investment time – the higher the profitability, the shorter the investment horizon:
- Conservative instruments (bank deposits, government bonds) have low profitability and, accordingly, do not allow achieving the set goal quickly. At the same time, the reliability of such investments is very high.
- High-yield assets naturally narrow the investment horizon, but they also increase risks. There is a risk not only of losing part of the invested funds, which will postpone reaching the goal but also of losing all investment capital. However, investors should also consider the overall market’s nature. For example, the stock market is inherently growing, allowing investors to not only “ride out” downturns but also gain significant profits over long investment periods. Currency, futures, and some commodity market assets do not have these properties.
This is why experienced investors link the investment horizon to the portfolio structure:
- For short-term (1-3 years) investments, it is recommended to choose assets with high reliability and low volatility. The ratio between conservative and income-generating assets should be around 80 to 20 (80% – bonds, preferably government, 20% – stocks, giving preference to blue-chip stocks).
- With an investment horizon of 5-10 years, the share of stocks can be increased to 40-50%. Part of the bond portfolio can also be revised by allocating up to half of its volume to corporate bonds from reliable issuers.
- A long-term investment horizon (10 years and more) allows focusing mainly on high-yield assets. The share of stocks is recommended to be increased to 80%, paying attention not only to “blue-chip” stocks but also to interesting second-tier issuers.
All the considerations mentioned above relate to a limited investment horizon. However, it can also be infinite, for example, when the investment goal is to obtain a constant primary income. In this case, assets should be chosen based on the correct ratio of dividend/coupon and speculative income.
Investment Horizon for Beginners
There are no fundamental constraints on choosing a specific investment horizon for newcomers to the market. The only recommendation given by experienced investors is not to invest all capital immediately into a long-term portfolio. Building a high-quality long-term portfolio requires a solid knowledge base and experience working with assets across different markets and industries.
To accumulate such experience, it’s better to allocate a portion of funds to short-term (1-3 years) investments. It is advisable to follow all recommendations regarding the selection of reliable assets and diversification.