Your investment horizon is the length of time, in years, that you invest before you begin to use the money. For example, if you invest for your retirement in 25 years, your investment horizon is 25 years. Investment horizon is also called your time horizon.
Investment horizon is also influenced by another point in time -- the duration over which you expect to use the money.
For example, if you retire in 25 years and live for another 30 years, your investment horizon is 25 years but your need to live off your retirement fund extends an extra 30 years. You need some of the money upfront, but the rest of it can be invested for future withdrawals. (This practice of taking out periodic amounts from a growing lump-sum investment is called annuitization.)
As a rule, the longer your investment horizon, the more aggressive you can afford to be as an investor. That's because you have more time to recover from declines in asset prices that inevitably occur. Aggressive investors with a long-term investment horizon can plan for higher expected returns than conservative investors since they have greater risk tolerance.
The following table shows that if you take out $30,000 at the beginning of the first year from a retirement fund of $350,000, the fund lasts between 15 and 16 years. We assume your fund earns an annual rate of return of 7.5% and that withdrawals grow at 3% a year to keep up with inflation.
If you expected to live in retirement for 30 years, you would have depleted your retirement fund. Most likely, you would depend entirely on Social Security during those extra years unless you returned to work for extra income.
If you stretched out the same retirement fund over 30 years, you would only be able to withdraw a little more than $20,000 a year, cutting into your quality of life in retirement.
To avoid either of these scenarios, you can invest more aggressively in the hopes of building a larger retirement nest egg. You can also extend your investment horizon by postponing retirement a couple of years. This extra time in the workforce gives you a chance to save a larger nest egg.
Separate financial goals have separate investment horizons. For example, saving a retirement nest egg may be one goal. You may also want to save for a child's college education or a honeymoon vacation. To help you accomplish each goal, you may want to consider setting up separate savings plans.
This information should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.