Definition: The investment horizon designates how long an investor plans to hold its portfolio of securities to realize a profit based on the accepted risk.
What Does Investment Horizon Mean?
What is the definition of investment horizon? The investment horizon is a key element of portfolio investing because it implies how long investors are willing to hold their portfolio based on the profit they aim to realize to compensate for the risk they have undertaken for investing in certain securities.
Usually, young people set a longer investment horizon because they have more time to keep their portfolio invested and realize profits or offset the losses incurred. Normally, with a long-term horizon, investors feel more comfortable to take riskier investment decisions and capitalize on the market volatility. Instead, with a short-term horizon, investors need to be careful to avoid riskier investments, especially close to maturity, so that they don’t incur significant losses.
Let’s look at an example.
Example
Mike is a risk-averse investor. He holds a diversified portfolio of fixed income securities that he expects will have a relatively high return. On the other hand, Mike doesn’t have the patience to hold his portfolio for a long time period and furthermore, he is in for cash. Can Mike have a long-term investment horizon?
The answer is no. The investment horizon reflects an investor’s personal traits. Although Mike is risk-averse and it would be expected to prefer a long-term horizon to have time to recover for a market pullback, Mike has a short-term investment horizon as a result of his significant cash needs. If Mike felt secure about his income, would he choose a short-term horizon?
The answer is yes. The more secure an investor feels about his job income, the longer his investment horizon is. Mike feels insecure about his job, and he cannot bind his money for more than 2 years. Therefore, he holds a diversified portfolio of 65% fixed income securities and 35% equities and, without being too conservative, and as he approaches the end of his investment period he adjusts his portfolio accordingly.
Summary Definition
Define Investment Horizon: An investment horizon is the amount of time an investor anticipates holding his investment before he sells it to make a profit.
