Time Horizon

. . . Once we've determined the investor's investment objectives, it's time to talk about her time horizon. In general the longer the time horizon the more volatility the investor can withstand. If you have a three-year time horizon, you need to stay almost completely out of the stock market and invest instead in high-quality bonds with short terms to maturity. If you’re in for the long haul, on the other hand, who cares what happens this year? It’s what happens over a 20- or 30-year period that matters. With dividends reinvested, the S&P 500 has historically gained about 10% annually on average, which means your money would double approximately every 7 years. Sure, the index can drop 30% one year and 20% the next, but we’re not keeping score every year—it’s where we go over the long haul that counts. A good way to see the real-world application of risk as it relates to time horizon would be to pull out the prospectus for a growth fund and see if you can spot any two- or three-year periods where the bar charts are pointing the wrong way—then compare those horrible short-term periods to the 10-year return, which is probably decent no matter which growth fund you’re looking at. That’s why the prospectus will remind folks that they “may lose money by investing in the fund” and that “the likelihood of loss is greater the shorter the holding period.”

Younger investors saving for retirement have a long time horizon, so they can withstand more ups and downs along the road. On the other hand, when you’re 69 years old, you probably need some income and maybe not so much volatility in your investing life. So the farther from retirement she is, the more likely she’ll be buying stock. The closer she gets to retirement, the less stock she needs and the more bonds/income investments she should be buying. In fact, you may have noticed that many mutual fund companies are taking all of the work out of retirement planning for investors, and offering target funds. Here, the investor picks a mutual fund with a target date close to her own retirement date. If she’s currently in her mid 40s, maybe she picks the Target 2030 Fund. If she’s in her mid 50s, maybe it’s the Target 2020 Fund. For the Target 2030, we’d see that the fund is invested more in the stock market and less in the bond market than the Target 2020 fund. In other words, the fund automatically changes the allocation from mostly stock to mostly bonds as we get closer and closer to the target date.Series 7 Exam Help