Your time horizonTime horizon The length of time that you plan to hold an investment before you sell it. This may be a brief period of time or span as long as decades, depending on your financial goals.+ read full definition is the length of time you expect to hold an investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition. The time horizon you choose and the risk of an investment are related.
Risk and time horizon
Investments like cash and short-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition bonds carry little risk for an investor whose time horizon is short, for example, a person saving for a vacation in 2 years. However, they can be risky for an investor whose investment horizonInvestment horizon How long you expect to hold onto your investment. Based on when you believe you will need your money back. In most cases, the shorter the horizon, the less risk you will want to take with your money.+ read full definition is long, for example, a person saving for retirement. The low return on short-term investments may not keep pace with inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition, or be enough to meet the long-term goal. Learn how not taking enough risk can affect your ability to achieve your goals.
In comparison, stocks can be very risky for the short-term investor since their value may change frequently. People saving for a short-term goal could end up with less money than they originally invested. Stocks have a higher potential return than cash and bonds over the long term, and are better for investors saving for long-term goals.
Use this chart to see how the average annual return and risk of loss on a diversified portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition of Canadian EquitiesEquities Another word for investments in the stock market.+ read full definition changed historically in relation to time horizon.
Longer-term investors are in a position to allocate a larger portion of their portfolio to higher-risk investments like stocks than shorter-term investors because a longer time horizon is associated with lower volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition. This doesn’t mean that stocks are not risky over the long-term, but for long-term investors, stocks are more likely to provide higher returns.
Factors that can affect time horizon
Your investment portfolio is only one part of your wealth. Investors also have human capitalHuman capital Human capital is someone’s ability to generate income from work.+ read full definition, which is their ability to generate income from work. Human capital affects the amount of risk you can take when investing. If your human capital is high, you can afford to take more risk. If your portfolio loses money in the short-term, you have time to recover your losses and the ability to generate more income. If your human capital is low, you won’t be able to rely on employment income to compensate for potential losses. You can’t afford to take unnecessary risk.
Your human capital depends on a combination of factors that include your age, health, skill set and employment status.
Horizon risk is the risk that your investment horizon may be unexpectedly shortened. For example, you lose your job or the roof of your house needs immediate replacement. This may force you to sell some investments, including those that you had hoped to hold for the long term. If you are forced to sell investments at a time when the markets are down, you are likely to lose money.
To guard against horizon riskHorizon risk The risk that your investment horizon may be shortened because of an unforeseen event. This may force you to sell investments that you were expecting to hold for the long term. If you must sell at a time when the markets are down, you may lose money.+ read full definition, you can include some short-term investments in your portfolio. This emergency fund could be cash in a high-interest savings accountHigh-interest savings account A savings account that pays a higher rate of interest. Some rules apply. Examples: You may have to make a minimum deposit. You may have to do your banking by phone or Internet. You may also have to wait a couple of days to take money out.+ read full definition or short-term bonds. If you find yourself in a situation where you are forced to sell, these investments will limit your losses.
Generally, you should reduce your allocation of longer-term investments as you come closer to the end of your investment time horizon. This will help you avoid the risk of having to sell most or all of your investments at a time when the markets are down.
Learn which investments may work for different time horizons to see how even small amounts of money saved add up over time.