Investments are the best way to increase your money over time, but you must still have an investment time horizon to develop return objectives. When choosing the type of investments to include in your portfolio, it is essential to consider your investment horizon. Learn how time horizon influences investment decisions and how to find the optimal time horizon for your financial and lifestyle objectives.
A time horizon, or investment time horizon, is the duration of time an investor anticipates to keep an investment before withdrawing funds. Investment objectives and techniques substantially determine time horizons. For instance, saving for a down payment on a house, for perhaps two years, would be considered a short-term time horizon, whereas saving for college would be considered a medium-term time horizon, and investing for retirement a long-term time horizon.
What Variables May Affect Your Investment Horizon?
There are a variety of variables that can be utilized to ascertain an individual's time horizon. These include age, income, lifestyle, risk tolerance, and liquidity requirements, which are examined in depth below.
1. Age
In general, the younger an investor in commercial real estate is, the longer their time horizon. In contrast, the older an investor is, the less time they must wait to get their investment funds. A 30-year-old investor, for instance, would likely be a suitable candidate for a private real estate investment with a 10-year return period. A 70-year-old investor would likely not be as suited to this offer.
2. Income
Fundamentally, income and risk tolerance are highly connected. A person with secure, high-paying work can follow an investment strategy with a long-term time horizon since they are more confident that they won't require their invested funds unexpectedly. Due to the unpredictability of their financial needs, an investor with little income or one that is very changeable may not be able to adopt a long-term perspective.
3. Lifestyle
Spending closely correlates with a way of life. The greater a person's income, the greater their propensity to spend. This is known as "lifestyle creep," which might affect an investor's time horizon. A commercial real estate investor with considerable lifestyle expenses, such as food, travel, and entertainment, will generally have a shorter time horizon than a compulsive saver, who may be able to invest for a longer time period.
4. Risk Tolerance
Individuals tend to create their investment portfolios in accordance with their level of risk tolerance. If a person can tolerate high levels of risk, they may attain greater profits, but this will take a longer time horizon. Among the riskiest investments are real estate development projects, common stock, and cryptocurrencies. On the opposite end of the scale, those with a lower risk tolerance may generally be better suited for short- and medium-term investments. These may comprise single-tenant real estate and bonds with a short duration.
5. Liquidity Needs
A person's liquidity requirements may be one of the most influential factors in establishing their time horizon. If a person wants access to their funds in the near future, they are unsuitable for any sort of commercial real estate investment with a long-term necessity. If a person does not anticipate using their money for an extended length of time, they may pursue long-term investment opportunities.
For instance, assume a parent opens a college fund for their newborn child, knowing that the money will not be needed until the child is 18 years old. They can afford to be long-term investors with this type of long-term purpose. However, if they intend to use the money for house upgrades in three years, they will invest for a considerably shorter period of time.
Various Investment Time Horizon Types
A time horizon for investments is the investment of time one intends to hold an investment for a certain purpose. Investments are typically divided into two categories: stocks (riskier) and bonds (less risky) (less risky). The longer the investor's time horizon, the more aggressive or risky the portfolio they can construct. The shorter the investor's time horizon, the more conservative or risk-averse the portfolio may be.
Investments having an expected duration of fewer than five years fall under the short-term horizon category. Those who are saving for retirement or anticipating a large cash outlay should consider these options. You should invest in money market funds, savings accounts, certificates of deposit, and short-term bonds if you need access to your money in a hurry.
Medium-Term Investment Time Horizon
Individuals who are saving for a longer-term goal, such as a college education, a wedding, or a first home, typically hold investments with a medium-term tenor. The best way to protect your savings from inflation over the medium term is to invest in a diversified portfolio that includes both high-risk and low-risk assets, such as stocks and bonds.
An investment horizon of ten years, twenty years, or more is considered long-term. The most prevalent form of long-term investment is retirement savings. Typically, long-term investors are willing to accept bigger risks in exchange for greater returns.
Short Time Horizons Vs. Long Time Horizons
Zero- to ten-year time horizon
Typically, investors with a short-term, or roughly zero- to the ten-year horizon, seek to maintain their liquidity. There is a significant difference between needing liquidity in zero to five years versus five to ten years. Therefore an individual's short-term investing methods may vary depending on her specific demands. For instance, a person desiring flexibility may only invest in commercial real estate through a real estate investment trust (REIT), whose shares can be bought and sold as easily as stocks. Those with a five- to the ten-year horizon may be more interested in investing in excellent cash flow deals now or throughout this time frame. A person nearing the conclusion of this short-term horizon will seek to invest in "safer" markets with consistent income and appreciation-driven growth. Sourcian is a dedicated platform for the recommendation of the best manufacturers. Your sourcing journey starts right here at sourcian.
Ten- to 20-year time horizon
A person with a 10- to 20-year time horizon will likely adopt a more diversified investment strategy. When investing in real estate, this may take the form of investing in communities with robust local economies, robust job markets, and ongoing expansion ambitions. These regions often have robust current cash flows with opportunities for expansion. A person with a medium-term time horizon may be interested in value-add real estate agreements in which the investor intends to purchase, renovate, and stabilize the property before refinancing, allowing investors to cash out their original investments and their preferred returns.
Medium-term investments are frequently made through leveraging other assets, such as by drawing on credit lines to fund the investment opportunity. The term of the investment affords the adequate investor time to repay this commitment while also expanding their portfolio's equity.
20+ year time horizon
An investor with a time horizon of 20 years or more has the greatest flexibility to invest in riskier real estate transactions. The lengthy runway affords investors the most time to recover from severe economic shocks or market corrections. Obviously, this does not mean that investors should abandon all caution. They should still select a diversified portfolio, investing in some assets with low risk but possibly investing a larger portion of their portfolio in less conservative options with higher returns. This could encompass both value-add and ground-up real estate transactions. It may also involve investing in secondary or tertiary markets that exhibit potential but are currently off the radar of institutional investors. As opposed to an investor with a shorter time horizon, who may choose to invest solely for in-place cash flow, an investor with a longer time horizon may look for transactions that have the potential to appreciate in value.
Why Is The Investment Time Horizon Important?
Your time horizons determine your investment portfolio. Generally speaking, a portfolio's level of risk increases with its holding period length. Typically, risk in this context refers to exposure to the stock market via individual stocks or equity mutual funds. A longer time horizon gives the portfolio additional time to recover if the stock market suffers a decline.
Changing your horizon throughout time is vital. A target that is ten years distant today will be considerably closer in five years. Too lengthy adherence to an investment strategy with a long-term time horizon is a frequent error made by investors. Suppose an investor begins saving for retirement, a goal with a long-term time horizon, using a plan with a high stock market exposure. Throughout the duration of their investment, the market has had multiple downturns but has ample time to recover because of the long-term horizon. The market crashes because the investor fails to reevaluate and change their portfolio to reflect their altered time horizon as they approach retirement. With less than a year until their anticipated retirement date, the value of their nest egg is significantly lower than it would have been if they had shifted their portfolio to shorter-term investments.
An investor's time horizon is continually evolving due to factors such as age, changes in their financial condition, and new aspirations. It is even feasible for numerous time frames to coexist simultaneously. Perhaps you are saving for retirement while also planning to pay for your children's college education or purchase a new home. Reviewing your objectives and the timeframes associated with them on a regular basis is essential to a solid financial strategy.
What Are The Implications of Time Horizons For Alternative Investments?
Alternative investments are typically more illiquid than conventional investments, and thus they are only suitable for investors who are willing to invest capital over an extended period.
For instance, funds dedicated to venture capital often last for ten years. Individuals or groups make a 10-year commitment to a venture capital firm in exchange for the opportunity to invest a predetermined sum of money with other donors to a pooled fund. Investors enter the fund understanding they may not have access to their investments for a number of years, while payouts may be made during this time depending on the fund's exit events.
Another alternative investment that requires patience is purchasing real estate. There have always been rich opportunities in the real estate industry for anyone patient enough to wait for a booming market. There is more money to be made by selling a home in 2021 as opposed to 2019 due to the increased value caused by the recovery from the coronavirus (COVID-19) epidemic. Institutional investors, who typically hold on to their real estate holdings for 7.6 years, follow the same trend (pdf).
Real estate isn't a good choice for investors looking for a quick return because of the many factors that make it impractical, such as financing and leasing agreements. For these reasons, only patient investors should think about diversifying into real estate.
How to Determine Your Time Horizon?
Fortunately, picking a time horizon is rather straightforward for investors. For example, if you have a substantial payment due within 24 months and want to invest in assisting in covering a portion of the cost, you should choose a 24-month time horizon.
Typically, investors do not have particular time frames such as the one presented in the preceding example. They typically seek to accumulate riches or prepare for retirement, and these objectives may assist them in reaching certain financial milestones along the road. Using this strategy to choose a time horizon can be quite complicated for investors. Therefore, it is advisable to explicitly define your time horizons so that your funds are there when you need them.
Investors must always have a time horizon when managing their portfolio. Once they have a concept, they can create a financial plan outline with many time horizons and investments to correspond with each option. Typically, an investment's underlying structure dictates this asset's optimal time horizon. By shortening the time of an asset or lengthening its life, the investor's returns may not be maximized.
Investment Horizon And Risk
Depending on the time horizon, a risk emerges differently in all investments. Your plan should be altered accordingly. In the near run, the risk reveals itself quite clearly. The market is unstable and fluctuates frequently. Consequently, losses are an element of the risk. The growth is negligible in comparison to the risk assumed. In addition, the recommended short-term investments (such as bonds and CDs) give modest returns relative to inflation (less than 1% for savings account interest). The risks and returns associated with short-term investments are fairly clear.
Long-term, the risks, however, are not so obvious. For instance, stocks are recommended for long-term investment horizons due to their upward horizon, but they suffer a significant decline when the market crashes. And an initial loss of this magnitude may induce fear and the desire to sell. When investing in riskier assets, you must assume both positive and downward trends as an investor. In addition, assets may experience a gradual decline from which they may never recover (e.g., oil). In such situations, selling everything and cutting your losses may be best. On the other hand, sticking to long-term investment may cause you to miss out on possibilities to earn substantial earnings. For instance, selling your stock options to purchase a more profitable asset in order to increase your profits. This issue is not inherently dangerous but represents a squandered opportunity.
There is also the issue of illiquidity, as you cannot access the funds when you need them, and if you do, you will lose the investment's growth. Consequently, you will need to set aside liquid funds for emergencies.
Summary
Before making any investment, whether in commercial real estate or otherwise, an investor should examine the impact of numerous aspects on her time horizon. Understanding one's investment aims and ambitions influence the time horizon. In general, your investment time horizon will dictate the types of assets you should invest in and the risk profile of each.
On the basis of their investment horizon, the majority of investors will seek to construct a balanced portfolio. Meeting with a financial consultant to discuss how various investments will affect your portfolio can be extremely beneficial.
FAQs
How Should Multiple Time Horizons Be Handled?
The majority of investors have diverse time horizons for various investments. For instance, a young couple may be saving for both retirement and the down payment on a home they expect to purchase in three years.
Keeping money with varying time horizons in separate accounts might help investors maintain order. They may also seek assistance from a financial planner.
What Is The Ideal Investment Horizon?
Since interest grows exponentially, a longer investment horizon can provide significantly bigger returns than a shorter one. This is why it is essential to begin saving for retirement as early as possible: a tiny investment made today can provide big returns if it has decades to grow.
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