What is a time horizon in terms of investments?
Time horizon represents the period over which an investor will evaluate success or failure. When considering investment opportunities, having a firm understanding of time horizon can help an investor manage expectations.
Why are they important to know?
Hands down, the most common question I receive is “What do you think of the markets?” The answer has EVERYTHING to do with the investor’s time horizon, which can vary person-by-person.
Someone with a long-term time horizon, like Warren Buffett, evaluates investment decisions over the course of many years or even decades. Buffett is quick to point out that he’s not concerned about the next 6-, 12- or 18-month stock price performance of any business he owns. Buffett’s long-term time horizon leaves him less concerned with short-term fluctuations, even when they work against him.
An investor today with a long-term time horizon could make an argument for the stock market being in an uptrend. Here’s a look at a monthly line chart of the S&P 500 going back to 2007:
However, an investor with a shorter-term time horizon of days or weeks may view the trend differently. Here’s a daily line chart of the S&P 500 going back to early-2022:
Not all investors have a long-term time horizon like Warren Buffett. Many investors evaluate their successes and failures over much shorter time periods including quarters, months, weeks, days and even hours. The most extreme example might be a high frequency trader whose time horizon could be fractions of seconds.
How can investors calculate their own time horizon?
An investor’s time horizon can be better understood through the lens of financial planning. Generally speaking, portfolios are invested to help fund future goals (i.e. retirement, wedding, college…etc.). By memorializing future goals into a financial plan, the time horizon for portfolios earmarked for each goal becomes clearer. If retirement is years (or decades) into the future, while funding college education is right around the corner, one should consider their time horizon for retirement funds to be longer than that for college funds. Awareness of the time horizon surrounding goals can help investors set expectations accordingly.
Finally, it’s important to understand the time horizon behind recommendations given from “experts” in the media. Otherwise, a simple “buy” or “sell” recommendation can be taken out of context. For example, strategists are often encouraged to debate their opposing views on one company – it makes for great television. One strategist generally suggests buying, while the other recommends selling. Keep in mind, the strategist with a buy recommendation may have a long-term time horizon while the strategist recommending a sell has a short-term time horizon. If the company in question declines over the coming weeks, but then proceeds to a multi-year rally, then both strategists were arguably correct in their call. By not having a full understanding of each strategist’s time horizon, a viewer could easily misinterpret one side of this common interaction.