What is the Investment Horizon?
Investment Horizon describes the time limit of the investment portfolio or security that the investor is likely to hold for before selling it. The investor may invest in the securities from a few days or hours to a few years to a few decades depends upon the need for funds and the risk capability of the investor.
Investment is also based on the analysis and research about the securities. It is also probable that the investor wants to invest for a longer time, but the time limit of the portfolio is shorter. Investors can also liquidate the investment in the middle due to continuous loss by the portfolio. This is called a break in the investment horizon. Pension plan, provident funds, and other similar investment are examples of investment plans. The higher the time of investment higher the risk and return, whereas shorter the time of investment determines lower the risk and returns from the investment, which is reflected and can be understood from the chart and the example given below.
There are three types of Investment Horizon named Short term, medium-term, and long-term:
#1 – Short Term
In this horizon, the time limit of holding the investment is shorter; it may range from a few hours to a few months. The time period is lower than the three years. The risk involved in this horizon is generally low. In this, the securities of investment include a certificate of depositCertificate Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period., bank deposit, fixed income securitiesFixed Income SecuritiesFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities., and other safe securities.
#2 – Medium-Term
The time limit in the medium-term investment horizon ranges from three years to ten years, and the risk is moderate in nature; sometimes, the risk factor is high also. The investment includes investment in shares, derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. , commodity marketCommodity MarketThe commodity market is a place where people buy and sell positions in commodities such as oil, gold, copper, silver, barley, wheat, and so on. Started with agricultural commodities, there are now fifty main commodity markets throughout the world, dealing with over a hundred commodities., medium-term bank deposits, mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc, etc. the securities hold a moderate risk and moderate returns.
#3 – Long Term
In this horizon, the risk is very high, and returns are also very high. The time limit of investment ranges from 10 years or more. The nature of securities involves investment in real estate sectors, high-risk securities, pension funds, provident funds, etc. the people who are willing to take more risks generally invest in long term investment horizon.
Example of Investment Horizon
Mr. M, a retired person, gets the heavy amount on retirement, and he invests the whole amount in a long term fixed income securities and for buying a new home. Hence the time limit is high, i.e., more than 20 years and returns are also high as the real estate industry is continuously rising, and the return on long-term fixed income securities is also very high. So, it is considered a long-term investment horizon.
Mr. A, a state government employee, started investing in 457 plans457 PlansThe 457 Plan is an IRS-approved tax-advantaged retirement contribution plan that provides retirement benefits to only eligible employees such as state and local government employees, non-federal employees, and employees of tax-exempt entities such as charitable institutions and NGOs offered by state governments, so the type of investment is considered as a medium-term investment and return is also moderate. So, the plan is considered a medium-term plan.
Mr. Y, an investor, has excess funds for a few years, so he invested in a fixed deposit for two years. The plan is considered a short-term investment plan as the risk, return, and period of investment is low.
Mr. A, a Government Employee, invest in the pension fundPension FundA pension fund refers to any plan or scheme set up by an employer which generates regular income for employees after their retirement. This pooled contribution from the pension plan is invested conservatively in government securities, blue-chip stocks, and investment-grade bonds to ensure that it generates sufficient returns. to save for retirement. The type of investment is considered as long term investment horizon as the risk is moderate, and the period of investment is long, so the chances of higher returns are there.
How Does it Affect Mutual Funds?
The time period and risk factor affect the investment by the mutual fund. It generally invests in mutual funds according to the need of the customers; they invest in short-term plans, medium-term plans, and long-term plans. Like investment plans, a mutual fund is also classified as short-term and long-term plans. The persons who want to invest in mutual funds can also invest through the investment horizons as they are considered as secured for investment.
The mutual fund companies also approach the managers of this horizon for investment in mutual funds. It gives business to mutual fund companies.
Investment Horizon is the term used to describe the time limit of investment. It is also called a time horizon. In this horizon, if the time of deposit is low, the funds are invested in safe securities, and the returns are also less. If the time of deposit is medium, the funds are invested in mutual funds, shares, derivatives, etc. the returns are also moderate. If the period of holding the investment is higher, the funds are invested in risk-based securities like foreign exchange, hedge funds, real estate sector, etc. the returns are also higher in the long term investment horizon.
This has been a guide to what is Investment Horizon and its meaning. Here we discuss types, importance, and how investment horizon affects mutual funds along with an example. You can learn more about financing from the following articles –