What is Investment Horizon and How Does It Affect Mutual Fund Choices

Updated on: Jan 11th, 2022


6 min read

The period over which investors stay invested in an investment option is referred to as the investment horizon. This investment horizon decides their desired exposure to risk and income needs, all of which contribute towards the selection of securities. Determining the investment horizon is one of the crucial steps an investor must take when creating a portfolio.

What is an Investment Horizon?

As an investor, remember that your choice of level of risk and the investment horizon will play a significant role. Make sure that safer debt investments fund your medium and short-term goals. Bank deposits are a good investment, as are liquid funds that can help you reach your short-term goals of a few months to a year. For goals that span a couple of years, you may choose from short-term debts to bank deposits. If your investment horizon exceeds five years, then equity is a good bet.  

When your investment horizon extends in length, the equities bring a higher risk-adjusted return as compared to income securities of fixed nature or cash. In short, investment horizons and equities tend to get riskier as an asset class because there are higher levels of volatility attached to them.

How are Mutual Funds classified based on Investment Horizon?

Depending on the type of mutual funds, the investment horizon for the same can be classified as short-term, long-term, and medium-term funds.  

Short-Term Mutual Funds

These funds usually have an investment horizon of 1-3 years. A period of fewer than 36 months for debt funds and less than 12 months for equity and balanced funds is defined as a short-term investment horizon.  

Medium Term Mutual Funds

These funds have a longer investment horizon of more than 36 months (3 years), and the investors typically stay invested for 5-7 years. Debt funds with an investment horizon of 1-5 years and equity funds with a tenure of 3-7 years fall into this category.  

Long-Term Mutual Funds

These funds have the most extended investment horizon that can last up to 10 years or more. Debt funds with tenure between 5-20 years and equity funds with an investment horizon of 7-20 years fall under this category.  

How do Investment Time Horizons affect your Portfolio?

If you want your investment portfolio to have proper diversification, then you must ensure that it comprises of various asset classes. You can look at a longer investment horizon and be able to take more risk as this allows the market many years to recover. 

  • If you are looking at long-term investments of say, more than 10 years, then your portfolio should have a significant portion dedicated to investments in equities. (Even within the equity class, you can allow a bigger portion of your portfolio to riskier assets. This could include options like a small-cap, mid-cap, and even international stocks. Generally speaking, about 70% to 100% of your long-term investment horizon portfolios should be in the form of equities and the remaining in fixed income).
  • With the time horizon reducing, there can be adjustments made to the portfolio as and when needed. This way, you can move more of your portfolio into fixed income from equity investments.
  • The things about fixed-income investments are that they offer you certain stability of principal even though they give you a much lesser return in the longer run. There should be provisions of about 30% to 70% of your portfolio to include equities if you are aiming for a mid-term investment horizon. The remaining portion can be invested in fixed income.
  • When investing in portfolios of short-term investment horizon, allot about 70% to 100% of your assets to fixed income and the remaining in equities.
  • When you are nearing the end of your investment horizon, to minimise risk, you must allow most of your investments towards fixed-income investments. This will help protect your portfolio from the severe downfall of the equity markets and also keep the principal amount.    
Investment horizon

Time Horizon for Other Investments

Certain investment options have a structure with their own time horizons. For the long-term investor, stocks are considered ideal as small-cap stocks are known to be risky: For the long-term investor, stocks are considered ideal as small-cap stocks are known to be of a risky nature. 

  • In the case of a bond, it has a maturity date associated with it, and once it reaches its maturity, the investment gives you the par value of your investment.
  • There is a maturity period attached to Certificates of Deposits (CDs) as well. Like bonds, CDs on their maturity offer investors the par value.
  • In the case of a fixed annuity, the time is set by the insurance company when the interest rate is paid to the annuity owner. On the expiration of time, the owner has the option of either continuing with the new interest rate or surrender the contract. Investing in mutual funds is subject to market risk, read instructions carefully before investing. Visit the ClearTax page to select funds that are hand-picked by our experts.  

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Quick Summary

Investment horizon refers to the period investors remain invested, affecting risk exposure and income needs while choosing securities. It is a critical step when creating a portfolio. Mutual funds are classified based on short-term, medium-term, and long-term investment horizons. The time horizons influence portfolio diversification and risk tolerance, with equities being more suitable for longer horizons.

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