Time Horizon is the Investor's Best Friend. Here's Why.
Sometimes, it’s not how much you invest, or even what you invest in, but rather when you buy and sell that matters most of all. That’s why one of the most important aspects of investing is determining an accurate time or investment horizon for every asset you acquire.
It’s simple: An investment horizon is the length of time an investor plans to hold an asset. It starts with the date they buy it and extends to whenever they’re planning to sell it off to capitalize on their investment.
For instance, if your goal is to make a little extra money for next summer’s vacation, your investment horizon would be considered short-term. It would likely last only a few months. On the other hand, if you’re thinking about retirement decades in the future as the goal for your investments your time horizon would be considered long-term.
Regardless of length, investment horizons are fundamental to informing other key aspects of a successful investment strategy.
Time Horizon and Risk
Investment horizons are an essential component of smart investment because different financial instruments offer very different levels of return relative to risk over a given period of time.
A stock’s price may surge one day, fall the next, and by year-end be down 5%. Over the same period, savings in a money market account may make 0.16% interest.
Looking 15 years down the road, however, this picture is likely to look quite a bit different.
The day-in, day-out volatility of the stock price will smooth into a discernible trend, and there is a fair chance that the trend will be upward, perhaps significantly so if the company was a worthy investment. Over this same 15-year period, the amount of money in the money market account will not decline, but interest payments will likely not keep pace with inflation, and the value of the savings will likely be worth less than the amount originally deposited.
These two investment instruments are both valuable tools to the savvy investor, but it is important to match their unique features with the correct investment horizon.
An investor who plans to spend the next 30 years investing for retirement has the time to ride through the short-term volatilities of the stock market. Short-term fluctuations do not matter so long as the long-term trend is positive. For the investor who plans to retire in two years, however, perhaps the money market account is the smarter choice. If the stock market drops on this investor, there may not be enough time to recoup the losses. A minimal gain in a safe place may make more sense for such a short-term investment horizon.
Using Time Horizon to Profit
In early 2018, Warren Buffett’s Berkshire Hathaway purchased an astounding 75 million shares of Apple. The company already owned 165 million shares of the tech, and this new acquisition made it the third-largest Apple shareholder in the world.
In an interview with CNBC after the stock purchase, Buffett, was asked if he was concerned about a recent disappointing sales report of a new Apple product. He argued that it didn’t make sense for long-term investors of Apple stock to obsess over short-term sales. “Nobody buys a farm based on whether they think it’s going to rain next year. They buy it because they think it’s a good investment over 10 or 20 years … The idea that you’re going to spend loads of time trying to guess how many iPhone X, or whatever it may be, are going to be sold in a given three-month period totally misses the point. It’s like worrying about the number of BlackBerrys 10 years ago.”
Arguably one of the most successful investors of all time, Buffett’s investment strategy hinges on making long-term investments in valuable companies. He looks for companies with solid fundamentals and a clear competitive advantage. He famously invested over $1 billion in shares of Coca-Cola in 1988 following the stock market crash of 1987. Coca-Cola had solid fundamentals and a clear competitive advantage in the beverage market, and Buffett recognized that the stock market was undervaluing the potential and long-term value of the company. Thirty-plus years later, Coca-Cola is Berkshire Hathaway's third-largest holding, and the stock has generated annualized gains of more than 11% since 1988. Buffett purchased Coca-Cola stock in 1988 at $2.45 per share, and as of November 2019, the stock is trading at about $53.00 per share.
If Warren Buffett had a short-term investment horizon in 1988, his Coca-Cola investment would not have performed particularly well. Stock prices for Coca-Cola experienced significant drops in 1998 and again in 2008. A panicked investor might see these drops as evidence that Coca-Cola was doomed and that it was time to jump ship, but an experienced investor doesn’t value the day-in, day-out volatility of the stock market more than his core investment principles.
As Buffett noted in his 1996 letter to Berkshire Hathaway shareholders, “If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.”
Of course, not every investor has Warren Buffett’s fortitude for riding out the stock market’s waves, but all investors can learn from his success in making long-term, carefully-researched investments.
Starting early and having a long-term investment horizon maximizes one’s investment potential. Attempting to “time the market,” or rebalance investments based on predictions and short-term swings, simply does not work as an effective investment strategy, either in the short- or long-term.
What does work, and what most experts recommend, is taking the time to evaluate your investment needs, including your investment horizon, values, and risk tolerance, and approach your investment like a long jog instead of a dead sprint.