Let’s assume that you are investing to build a corpus for down payment of your house in another 2 years. In this case your time horizon would be 2 years, and in such a case it is best to invest in bank FDs or debt funds. The rate of return is lower, but they are assured.
On the other hand when investing in long-term goals like retirement, the time horizon is much larger and investing in equities directly or mutual funds can yield higher returns because market volatilities even out over a period of time.
The time horizon of an investment is nothing but the length of time an investor aims to hold an investment before selling it. The time horizon of the investment is important for several reasons. First it is an indication of how much risk an investor is exposed to. When the term horizon is short, an investor is exposed to more risk. However, when the time horizon is long an investor can take more risk since the market has a chance to bounce back even if it falls.
“Time is the most critical aspect of investing. Understanding one’s personal time horizons and the ability to stay invested for the longest time possible allows the magic of compounding to make you rich,” said Satyen Kothari, Founder and CEO, Cube Wealth. One may divide one’s money into separate buckets for this purpose.
“The first is the emergency bucket. These can, by definition, happen anytime. This money should be in a safe investment that also earns you good interest. We would suggest investing in liquid funds since these earn more than savings accounts at about 7% and can be removed anytime without penalties, unlike an FD,” says Kothari.
The second bucket is the money you need for expenses that are coming up soon in the next 3 years. These can be saving up money for a down payment of a car or house or for your children’s education in a few years time. You will not want to invest in equities because the markets may fall sharply and you may suffer heavy losses. “Do not fall for sales pitch that you should add this money to mutual funds to get higher returns,” cautioned Kothari. In such a situation the money is best kept fixed deposits with a certain time period. Investing your money in medium term debt funds is another option.
The third is long term bucket for the money where you need the money after 5 or more years. “This is the one you want to maximise for long term wealth creation to meet goals like your children’s education or retirement. Here it is recommended that one invests in equity funds based on one’s risk appetite. With a goal that is 10 or more years away, investing in aggressive equity funds can reap benefits for the investor. The aggressive investor may also consider small and mid-cap funds.