The Real Risks Of Underestimating Your Investment Time Horizon


A volatile stock market can cause investors’ anxiety levels to rise. That unease is particularly acute among those near or in retirement who fear they may not have enough time before the market recovers.

That could be understandable if their investment time horizon were short, such as two to three years when they would need complete access to their money at the end of that period. If that were actually the case, they probably shouldn’t be in the stock market. However, for most investors, even those in retirement, their investment time horizon is longer than they think.

Why is that important? Because understanding one’s investing time horizon is critical to determining the optimal asset allocation for generating the returns necessary to achieve objectives. For retirees, their objective is to create a lifetime of income sufficient to maintain their lifestyle and, for many, to leave a legacy for their children. What does that mean in terms of their investing time horizon?

Retirees Shouldn’t Fear Longer Time Horizons

Consider a 70-year-old retiree with $1 million invested in the stock market, spending $50,000 a year, who views his time horizon as just three years because, as he says, “I’m not young anymore.” That might be the case if he were spending $333,000 a year, but in reality, three years is his time horizon for $150,000 of his portfolio, and much longer for the rest.

Depending on their personal and family health histories, most 70-year-old retirees have at least a 10-year time horizon, but they should plan based on a 20-year time horizon (longer with a younger spouse). Even at 10 years, retirees have little to fear from a market downturn. Since 1932, the stock market has never generated a negative return over any 10-year holding period.

A Cash Management Strategy Can Extend An Investing Time Horizon

There is even less to fear if they have sufficient cash reserves to cover living expenses during market declines. A sound investment strategy should incorporate a cash management component to help retirees avoid selling securities during a prolonged market downturn, which can accelerate the depletion of assets. The average bear market lasts around nine months, and the average time for the market to recover its losses is less than 12 months. So, based on historical market performance, a 24-month cash reserve could be sufficient to survive a typical bear market.

Modest Planning Protects Against Adverse Market And Economic Conditions

In addition, a well-conceived financial plan and investment strategy should account for market volatility and potential bear markets while factoring in the worst-case scenarios for inflation. Even though the stock market has generated an average annual return of 10.5% since 1972, a long-term financial plan may only want to assume asset growth of no more than a modest 5% to 7% annually. While the average inflation rate over the last 20 years is less than 3%, a more conservative assumption would be 4% to 5% for a long-term plan.

The idea of using more modest planning assumptions is to have a financial plan overshoot its objectives in good years and provide a cushion for not-so-good years. When combined with a cash management component, this approach can give retirees confidence in their financial security even during the worst economic and market conditions.

The Risk Of Investing Too Conservatively

The problem with retirees underestimating their planning time horizon is the tendency to invest too conservatively relative to their potential longevity. While investing in safe fixed-yield or guaranteed investments may offer peace of mind for the moment, it can’t protect against the threatening risk of inflation, which, when coupled with longevity risk, inevitably leads to asset loss over time.

For retirees fearful of stock market losses, it’s only a real risk if they actually sell their stocks when the market declines, turning paper losses into a permanent loss of capital. However, inflation and longevity are actual risks that can’t be prevented. But they can be alleviated with a sound investment strategy. Instead of fearing stock market volatility, retirees can learn to embrace it because it is what generates the level of returns needed to extend income while maintaining purchasing power.

The most effective risk avoidance strategy is to have a thoughtful long-term plan that anticipates potential risks and employs an optimal diversification strategy that can harness risks in a way that captures the returns of the market while reducing portfolio volatility to a tolerable level.


Jonathan Dash,
Founder and President

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.