There are several factors to consider when evaluating investment opportunities, such as volatility, expected returns, and risk tolerance. Another critical factor is time horizon. An investment’s time horizon, or longevity, can vary depending on the type of investment and the investor’s goals. It’s arguably the most important factor to take into account: For an investment to be successful, your strategy must allow you to access your money when you need it, however soon or far out that may be.
What Is an Investment Time Horizon?
An investment time horizon is how long an investor expects to own a particular security, or investment. Time horizons vary for different investment strategies—from a few days or hours to potentially decades.
Generally, a longer time horizon is more conducive to a riskier investment or set of investments, as it allows more time for the market to recover from any setbacks and for the investor to realize a gain. Investing, at its core, is a balance of risk and reward—you can forgo having access to cash for a certain amount of time with the expectation that it will later be returned to you with a premium for giving it up. Usually, the longer you give up your cash, the more you can expect to earn back.
Types of Investment Time Horizons
Time horizons vary and are often dictated by investment goals or strategies, which are closely related to liquidity. At the end of an investment’s time horizon, it’s fully liquid, or able to be cashed out or traded. Prior to an investment’s maturity, it’s illiquid, or unable to be accessed by the investor. Investors factor in liquidity when choosing which investments best suit their time horizon goals.
For retail or individual investors, time horizons can be dictated by a particular savings goal, such as retirement or purchasing a home. Institutional investors, however, are generally long-term investors, as organizations like pensions or endowments exist to provide returns for decades, if not indefinitely.
The structure of an investment makes it suited for different longevities, and trying to cut it short or extend its length can result in subpar performance. Additionally, there’s an opportunity cost: Not maximizing one investment might mean you could have better invested your money elsewhere.
The simplest investments with regard to time horizons have preset maturity dates. Bonds, for example, are designed to mature on a certain date, and investors purchase them knowing the exact date their money will be returned.
Other types of investments, however, can be more complicated. For example, when you purchase a stock, you can turn around and sell it at any time. But the stock market fluctuates constantly, so how do you know if you want to sell your stock the next day or the next year? These determinations depend on various factors, including when you need your money back and how you expect the market to perform in the future.
What Do Time Horizons Mean For Alternative Investments?
Alternative investments are generally much more illiquid than traditional investments, which means they’re only suitable for investors willing to invest cash over a long period.
For example, venture capital funds typically last for approximately 10 years. Investors commit a certain amount of money to a venture capital firm that invests it over the next decade, along with other contributors to the fund. While investors may receive payouts during that period—depending on the fund’s exit events—they enter the fund understanding they may not have access to investments for several years.
Real estate is another type of alternative investment that requires an investment strategy with longer time horizons. Historically, real estate has offered valuable opportunities for those willing to wait for hot market conditions. One only needs to look at the soaring price of housing in the United States during recovery from the coronavirus (COVID-19) pandemic to realize there’s money to be made by selling a house in 2021 versus 2019. The same holds true for institutional investors that, on average, hold real estate investments for an average of 7.6 years.
There are many elements of real estate that prevent it from being a quick turnaround investment, such as complicated financing or years-long lease terms. For these reasons, only investors with longer time horizons should consider adding real estate investments to their portfolios.
How Alternatives Differ From Traditional Investments
It’s important to note that traditional investments, too, can be advantageous for investors with longer time horizons. For example, one could simply purchase a stock and hold on to it for decades. The difference with stocks, however, is that the investment is much more liquid because the investor could choose to sell the stock for cash at any time. In the case of alternatives, this option might not exist.
Using Alternatives to Serve Longer Investment Time Horizons
There are many factors to consider when thinking about investment time horizons, including your age, liquidity needs, upcoming life events (such as retirement or buying a home), or the goals and needs of clients and partners (if you’re an institutional investor). For those with longer time horizons, alternatives offer a promising way to diversify portfolios, as the concession of giving up access to cash in the short run can result in higher returns in the long run.
The Importance of Investment Time Horizons
While investments can be measured in many ways, they cannot enhance your portfolio unless they provide access to your money when you need it; understanding time horizons is crucial to ensuring success. To learn more about how alternatives differ from traditional investments and the unique advantages they offer, consider taking an alternative investments course to learn strategies for building and diversifying portfolios.
Are you interested in expanding your knowledge of alternative investments? Explore our five-week online course Alternative Investments and other finance and accounting courses.
