Many people think that investing is just about finding the best way to grow your money as quickly as possible. But to make the right investments, you need to have a sense of your time horizon: how long you expect to own your investment after you buy it. If you can estimate the length of time you think it'll take to reach whatever financial goal you set for a given investment account, it can help you plan better and improve the likely success of the planning you do to reach your goals.
Good investments for short time horizons
If your time horizon is short and you'll need the money you invest in the near future, then you have a couple things working against you. First, you don't have much time to make your money grow. Second, if the stock market suffers an unexpected drop, you won't be able to wait it out in the expectation that an eventual recovery will come.
As a result, it usually makes sense to invest conservatively if you have a short time horizon. Bank savings accounts and certificates of deposit don't have very high returns, but they guarantee that you won't lose money, and that's the most important thing when you'll need your money within the next year or two. Other investments like short-term bonds can be a prudent move, but in general, you'll want to avoid stocks. Rolling the dice on a positive stock market move in any given year is a gamble that you typically won't want to make with money you absolutely need.
Investing for the long haul
By contrast, when you have a long time horizon, you have many more options for investing. With time on your side, you can seek out stocks in companies that have the greatest potential for long-term success. You can invest in the knowledge that you can wait out any short-term downturn and indeed even take advantage of short-term moves to invest more at cheaper prices.
The low returns that bank savings accounts and CDs offer make unsuitable investment for long-term portfolios, because the potential for growth becomes more important than the need for immediate capital preservation. Longer-term bonds offer higher interest rates than short-term bonds. But the best growth investment is generally in stocks and other higher-risk assets, because the volatility that those asset classes suffer over shorter periods of time tends to smooth out and leave investors with higher total returns in the long haul.
Time horizon is one of the most important aspects of building an investment plan. By knowing your time horizon, you can choose the investments that will help you reach your financial goals as expeditiously as possible with the greatest chance of success.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!