In meeting with individuals to discuss their investment planning horizon, I’ve noticed that there is a common misunderstanding of the concept.
As an investment horizon is a frequent section on investment questionnaires and forms, I want to break it down for you guys.
Anytime you open an investment account or a bank account, you’ll be asked the question:
Do you have a short-term or long-term investment horizon?
While your answer could be 4 years, 5 years, 10 years or more, the actual concept of investment time horizon is very important for the purposes of drawing out your assets and determining what your exposure to equities should and could be.
Therefore, the first step to determine your risk tolerance is assessing your ability to stomach movement in the market. Are you losing sleep at night? Are you stressing over a market correction?
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Another important factor is deciding whether you need your money in 6 months, 1 year, 2 years, 10 years or only at retirement. This, will have a significant impact on your investment strategy.
Let’s look at the following example.
A young couple just got married, they’ve put aside their first $50,000 and are saving for the future. The couple own their home, have a little bit of liquidity either through a credit line or a tax-free savings account and the rest of their assets are in their RRSP.
The couple are 25-30 years old and thus, have a very long investment horizon and are likely not going to touch that RRSP money till they’re 65 or 70.
The couple will likely go through many economic cycles: the highs and the lows.
If they do and if they are able to stomach the volatility through their mental fortitude or their intestinal fortitude, the time horizon question becomes less relevant for them because of their long-term investment horizon.
Contrary to that, there’s another young couple who puts their first 50K aside as a down payment for a house.
Now, if this young couple is set on the idea of buying their house shortly, then that couple should not be invested in equities and stocks.
Because who knows what will happen in the stock market in the short term. If we see a 20% correction in the market, that couple might no longer be able to use that 50K for a down payment. Consequently, the time horizon question becomes more relevant for them, as they most probably will use that money in the short term.
Accordingly, individuals either have a short, a medium or a long term investment horizon.
RESPs (Registered Education Savings Plan) and how it applies with the topic of investment time horizon
Let’s pretend you have a couple kids at home. They’re 3, 4, 5 and/or 6 years old. When it comes to their RESPs, think of your investment horizon for this specific investment account (RESP) as these kids grow and before they turn 18.
If you have a 5 year old, he/she will start using his RESP at 18 years old so that gives you a 13 year investment horizon. Therefore, you could own equities in that portfolio and over time, you could consider reducing the equity ratio in the portfolio as those cycles can generally be anywhere from 3 to 7 years.
The closer you get to the lower end of those years, the more you want to move towards some fixed income and some more defensive strategies.
The key factor you need to know with your investment time horizon is obviously your retirement date.
I often hear this misconception: ‘’When I retire at 65, all my assets need to be in cash.’’
I don’t believe this is right, I believe it’s a misnomer.
What usually happens and what I’ve seen with my own eyes with my clients is entirely different.
One would retire, then start drawing a little bit on their income.
Perhaps you have a pension, you have some other dollars coming in and maybe you have some real estate income coming in.
Regardless, you have some income coming in and some income needs to be derived from equities, dividends, dividend paying preferred shares, etc. It may also make sense to include some fixed income in there as well.
Over time, you should reduce your allocation of longer-term investments as you near the end of your investment time horizon. The team and I would welcome the opportunity to discuss what is best for your specific situation.
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