The investment horizon is the time period for which an investor remains invested in a financial instrument. It majorly depends on the financial goal of the investor, which s/he wants to fulfill through investment in any of the security. The risk exposure of the security, and the consequent selection of securities is also a factor of investment horizon of the investor.
The Three Types of Investment Horizon
Investment horizon has been further classified into three categories, based on the time duration for which the investor remains invested.
1. Short – Term Investment Horizon
The short – term investment time frame ranges from 1 – 3 years. Individuals who are about to retire, or have already retired usually have this investment horizon, as there are fewer years to realise profits and fulfill financial goals. In addition to them, individuals who wish to invest with the purpose of saving for short term goals such as buying a car, etc also have a short-term investment horizon.
This investment horizon is apt for risk-averse investors, who wish to invest in instruments with short-term maturity, which are highly liquid as well. They can either invest in treasury-bills, certificates of deposits, short-term bonds, or go for short duration debt funds such as liquid funds.
2. Medium – Term Investment Horizon
Investment period that ranges from 3 to 7 years is known as the medium-term investment horizon. Typically, investors with moderate risk appetite have this investment horizon, who look for a conservative and diversified portfolio.
Investors with this investment horizon can consider investing in equity shares of companies with large market capitalization, whose share price is less susceptible to market fluctuations. Or, they can go for large cap funds that predominantly invest in these companies. Also, there are certain medium-duration debt funds that are apt for 3-5 years of investment horizon.
3. Long – Term Investment Horizon
An investment time frame of more than 8 years is known as long-term investment horizon. This is the perfect time period for investors who wish to bet their money on risky endeavours, as there is significant time to contain losses and learn from one’s investment mistakes. This investment horizon mainly corresponds to investors who have just begun investing, and can wait for a considerable amount of time for the profits.
Equity shares with high growth potential, but quite risky due to market volatility are the perfect investment option for investors with this investment horizon. Even if the investor makes a wrong investment decision, s/he has enough time to make up for the mistakes and invest in a high growth equity share. Instead of directly investing in shares, investors can also choose Small Cap Funds or Mid Cap Funds for investment, if they’ve an investment horizon of more than 8 years.
If the investors have a long-term investment horizon, however, they still don’t want to put their money in risky avenues, they can opt for long-duration debt funds with a maturity period of 10 years of the underlying bonds.
Impact of Investment Horizon on Investor’s Portfolio
- The investment portfolio of investors with a short-term investment horizon largely inclines towards fixed income securities, which form almost 80% of the portfolio. Since there is less time to realise profits, the portfolio will majorly focus on debt securities with short maturity periods.
- A medium-term investment horizon calls for a balanced investment portfolio, with a little inclination towards debt securities. The portfolio may have about 60% allocation to fixed income and money market instruments, and the rest is allocated to equities. It should be noted that the selected equity securities have a stable past performance record.
- If you’ve a long term investment horizon, it is recommended that you have about 80% asset allocation to equity securities. The longer duration sets off the risk associated with the volatile nature of the equity asset class. The key idea here is to remain invested for a long duration, through a complete market cycle, to realise the maximum gains from the investment.