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The Importance of Investment Time Horizon in Asset Allocation Decisions

Clients who've endured conversations with me about their recommended asset allocation know how much I stress the importance of their investment time horizon.  During a recent discussion about investment ideas, my dad suggested "What's your time horizon?" be my epitaph.  Maybe so, but considering in advance when you will need the money you're investing can keep you from making the worst kinds of financial mistakes. And keeping your investment horizon in mind during periods of market turbulence should help keep you on course for attaining your financial goals.

Historically, our stock market experiences a 10% decline on average about every year and a 20% drop about every 3 1/2 years.  The moral of this story?  If you invest in the stock market for a couple of years before needing to tap your accounts for retirement expenses or any other financial obligation, you shouldn't be surprised if you lose money in the interim.

On the other hand, every one of our market declines has been followed by a recovery to new record highs in the years that followed.  Sometimes this journey back to new highs has been agonizingly long, but the Dow and the S&P 500 have always come through in time.  The 2000-2002 drop was one of the nastiest bear markets in history, and it only took 5 years for these 2 indices to make new all-time highs.

In essence, the stock market becomes less risky with time.  It's not unusual for stocks to decline in a given calendar year - it happens about every 4 years or so.  But it's exceedingly rare for a stock market index to decline over a 10-year period.  

(To read a further discussion on the importance of investment time horizon and a holistic financial perspective in reaching your financial goals, please click on How to Put Stock Market Volatility into Perspective.)

This is why the discussion about your investment time horizon is so critical in determining your asset allocation.  If your time horizon is long, you have the luxury of waiting to allow stocks to come back before you need your funds.  But if you're going to need to withdraw from your investment accounts in a year or two, a market decline can be disastrous to your financial future.

"Time, time, time is on my side - yes it is."

---- Mick Jagger

About the Author

Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.  

Contact Paul