In my experience in investor relations, meeting with hundreds of portfolio managers responsible for trillions of dollars invested in equities, one of my standard questions whenever I first meet a manager is, what is your investment time horizon? As a member of company management, you always hope to meet with investors that have a very long view of their investments, you want them to invest because they believe in your strategy and want to partner with you for the next five, 10 or 50 years. So inevitably, when answering this question knowing what we at the company want to hear, every portfolio manager will say, “we are long-term investors.” Whether they are a long-only fund with a half century of performance or a hedge fund that turns over their portfolio completely each quarter, everyone is a long-term investor. How is this even possible?
Charitably, I would liken it to the differences in perspective on time each of us experiences at various stages of our lives. When you are a small child, even if it’s less than a year until your birthday or Christmas, it seems like an eternity, so for a child, a year is definitely long term. As you enter adulthood, you see things that are worthwhile that take a bit longer, like earning your college degree or building your career. In this case a year is a pretty short time frame, so you might look at long term as four or five years or more. In a similar case, if you start saving in your 401(k) plan in your early career, with 30 or 40 years until retirement, that may become your standard for a long-term horizon. The bell curve seems to revert back as you approach your retirement years (or so I am told), where the uncertainty of life becomes more pronounced, so long term may become shorter again. After all, if you’re 85, planning 40 years out might not be as practical as it was when you were in your thirties.
So, if you are a hot shot hedge fund manager, long term might be a year or less, as things move so fast in your world. To a classical equity fund manager, long term might be five years or more, while for a fixed income manager at a life insurance company, long term might mean 25 years. As individual investors it benefits us to define our time horizon in an effort to optimize our returns and mitigate the adverse impact of some of the more volatile impulses of human nature. As humans we often allow our emotions to get the best of us when it comes to investment decisions, the impact of fear and greed which often leads us to buy high and sell low.
To help combat these impulses, it’s helpful to define our time horizon for our investments in more concrete terms. If we are investing in our 401(k) plan for our retirement, we know we have 20, 30 or 40 years or more to consider our investments. Yes, we may still make big mistakes like the many folks who sold out of their equity positions at the lows of 2009 only to hop back in at new record highs a few years later. We may still feel the inevitable pull of fear and greed, but knowing we have decades before we will need the proceeds of our portfolio may help instill a bit more discipline. In the same way, if we have investments geared toward shorter time horizons, we can better construct a portfolio to meet those shorter goals. If you plan to buy a house in the next five years, and you are saving for a down payment, you might put this money into short-term fixed income investments where the risk of loss is somewhat mitigated. Rather than putting that money into a hot new mutual fund, you might be better off with the 2-year treasury notes yielding 2.8%, allowing much better nights of sleep knowing your dream of home ownership won’t be ruined by a short-term stumble in the market.
As you increase your investments over time, remember to define your time horizon. A well-defined time horizon will help you construct a more appropriate portfolio to meet your goals, allow you to mitigate the risk of emotional decisions, and ultimately allow you to achieve your financial goals in both the short run and the long term.