Every time you invest, it’s important to think about when you may need the money. This timeline is the best way to find your investment strategy.
Generally the rule of thumb is - the longer you invest for, the more risk you can take and vice versa.
Your investment strategy should be shaped around reaching a goal, such as taking time off to travel, being financially independent or having a comfortable retirement.
To decide your investment horizon simply work out how long it will realistically take to reach that goal (based on average returns and the amount you are able to put aside each payday). For example, saving for a week of travelling may take three to six months, while saving for retirement usually takes several decades.
The secret to investing effectively for most people usually isn’t placing big bets on individual shares or watching the markets like a hawk. It’s repeating small actions consistently over a long period of time.
Higher risk investments may generate higher returns but they also have a higher level of volatility, meaning they go up and down in value.
When you’re investing for the long term (7+ years) the volatility is less likely to lose you money, because you can simply wait until your investments go up in value again (subject to the type of investment and other possible risks)..
However, if you’re investing in the short term (less than 3 years) and your investment dips in value then you may not have time to wait for them to recover in value meaning you may be more likely to lose money.
In other words, a longer investment horizon gives you more time to ride the ups and downs of the market.
You might want to buy a new car in a year or two. You may also want to buy a home in the next five years and retire in another 20.
Each of these goals have different investment horizons so it’s worth setting up different investments - each with a level of risk and volatility that’s appropriate. For example:
If you want to achieve your goal in less than 3 years, you may not have enough time to make the most of the share-market. It’s usually worth sticking to cash, a high-interest savings account, mortgage facilities, term deposits and cash and term PIEs.
For example, you could have a series of term deposits from one year to 18 months rolling off regularly.
Or, you could try put your savings in a revolving credit or mortgage offset account to reduce the interest you’re paying on your mortgage. Talk to your bank for more ideas.
In the medium term, which is around 3-7 years you may be able to afford to take a little more risk, but you’ll still want to be careful.
Some financial advisers recommend sticking to conservative funds, cash funds and maybe balanced funds. Others who are less risk averse advise a well diversified portfolio of ETFs or index funds for investment horizons of over five years.
The amount of risk you take depends on what you’re comfortable on and the flexibility of your investment horizon. For example, if you want to retire in five years but can wait a year or two for markets to recover you may be able to afford to take more risk.
When you’ve got a longer time from 7-10+ years you should be able to take a little extra risk. Your investments could include individual shares, growth or aggressive growth funds, ETFs, index funds and even a very small proportion of alternative assets like cryptocurrencies and NFTs. Property investment could also be an option.
When you invest and things don’t go your way it’s easy to panic and withdraw your money to limit your losses. But when it comes to most investments, including managed funds, ETFs and index funds, withdrawing during a downturn can lock in your losses.
Instead it’s important to continue to invest, control your emotions and wait for the market to recover.
Disclaimer:
This What is an investment horizon? is general information only. The views and opinions expressed do not necessarily reflect those of the FSC. It is not intended to constitute legal or financial advice and does not take your individual circumstances and financial situation into account. All investments carry risk, including the risk that you may lose more than your initial investment. We encourage you to seek assistance from a trusted financial adviser, legal or other professional advice.
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October 2023