Originally published at: How to invest based on your time horizon – InvestEngine Insights
Investing for a year or two is very different to building wealth for retirement. They require completely different approaches to be successful. This is because, fundamentally, the amount of time you’re investing for has a significant impact on the ideal assets to invest in.
In this guide, we’ll explore how investment risk changes depending on your time horizon and some of the different strategies investors employ when investing for the short-, medium- or long-term.
The dynamics of investment risk over time
Investment risk isn’t static; it changes as your investment horizon progresses. Understanding these dynamics can help you make better decisions.
Short-term volatility: In the short term, markets can be unpredictable and prices can swing. If you need to sell your investments during a downturn, you may take losses. By recognizing your time horizon, you can avoid panic-selling and stay focused on your long-term goals.
Long-term growth potential: While short-term investments may feel ups and downs keenly, a longer time horizon allows you to ride out fluctuations. For example, a stock may dip 20% in a year, but over a five- or 10-year period, it could grow. The longer you can keep your money invested, the more you can benefit from compounding returns.
Changing risk tolerance: As time progresses, your risk tolerance may evolve based on life circumstances. For example, a younger investor may be comfortable taking on more risk to chase higher returns, while someone nearing retirement might prioritise capital preservation. Regularly reassessing your investment strategy is essential to ensure your portfolio remains right for you.
Rebalancing opportunities: It’s essential to review and adjust your portfolio over time. This ensures that your asset allocation remains aligned with your risk tolerance and long-term goals. For instance, as you approach retirement, gradually shifting your investments from higher-risk assets to more stable options might suit you.#
Why time horizon matters
Your investment time horizon significantly impacts your strategy. Generally speaking, the longer your time horizon, the more risk you can afford to take. This is because markets can fluctuate in the short term but, historically, they have trended upward over longer periods.
For example, if you’re saving for a retirement that’s 30 years away, you might choose a more aggressive portfolio heavy in stocks. Historically, equities tend to outperform other asset classes over longer periods, despite their volatility. The longer you have to ride out market fluctuations, the better positioned you are to benefit from the compounding effects of your investments.
Conversely, if you are investing for a short-term goal like buying a car or funding a wedding, you may want to adopt a more conservative approach. Allocating a greater portion of your portfolio to bonds or cash equivalents can minimise risk and preserve your capital, ensuring you have sufficient funds when you need them.
Your time horizon and your options
Let’s take a look at different investment scenarios and the options you have that might suit your goals.
Short-term: <2 years
When you invest for the short-term, you’re likely to be focused on preserving your wealth and beating inflation. The priorities will be risk reduction and liquidity – you want to avoid losses and to maintain access to your cash.
These investors may want to consider money market funds. These are low risk, flexible, easy-to-use funds that give your cash access to the SONIA rate – the average interest rate published by the Bank of England which currently stands at 4.95%.
Medium-term: 2 – 10 years
For medium term investments, a balanced approach is likely to be the most suitable. You’ll want to achieve growth but don’t have the luxury of 10+ years to smooth out any major dips.
So, you’ll want a diversified, multi-asset portfolio made up of stocks, bonds, commodities and other varied asset types. Different blends will achieve different results, but a general rule of thumb is that you’ll want more equities if it’s a longer-term investment, and more bonds if you’re looking at the short term.
Long-term: 10+ years
Those investing for the long-term can afford to take on the most risk. This doesn’t mean investing recklessly, rather it means taking on calculated risk for the potential of higher returns.
Long-term investors often build a diversified portfolio primarily consisting of equities, with the diversification coming from investing in a range of geographies, industries and businesses. With a long-term horizon, you have the time to ride out any market downturns and tap into the fact that, over long enough timescales, markets have tended to grow.
Choosing the right strategy for your goals
To effectively navigate the complexities of investing, it’s vital to align your strategy with your specific goals. Here are some steps to help you identify and optimise your investment time horizon:
Define your goals: Begin by identifying what you’re saving for—retirement, a home, education, or something else. Each goal will have its own time frame, which will dictate your investment approach.
Assess your risk tolerance: Determine how much risk you are willing to take. Factors such as age, financial situation, and personal comfort with volatility will influence your risk tolerance.
Choose the right investments: Based on your time horizon and risk tolerance, you’ll want to choose appropriate investments. For long-term goals, you can weigh your portfolio more heavily to equities. For short-term goals, prioritise safer options like bonds and cash equivalents.
Monitor and adjust: Your financial needs and market conditions will change over time. Regularly reviewing your investments and adjusting your strategy is crucial to staying on track.
Consider professional management
If all of this sounds like a lot of work, you might want to consider professional investment management. InvestEngine’s own managed portfolios, for example, mean that a team of experienced portfolio managers can take care of your investments for you.
Our team builds portfolios and monitors markets daily to ensure that they remain fit for purpose. It doesn’t have to be expensive, either. Our managed portfolios charge just 0.25% a year in management fees – just 21p per £1,000 per month.
[Fill out our questionnaire]
Capital at risk.
All you have to do to get started is fill out a quick questionnaire about your financial situation and your goals, and we’ll do the rest. You’ll get a portfolio that’s suited to your investment goals and we’ll manage it over time to make sure you get the most out of it.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.