Key points

  • Accounting for an investor’s time horizon needs a rethink now that investments are no longer closely tied to singular investment objectives.
  • A specific subset of investible assets may have a time horizon, but the notion of a single time horizon is nonsensical when applied (as it often is) to an investor’s holistic situation. Each investor has multiple time horizons, because they have multiple withdrawal points and multiple goals.
  • Good risk capacity measurements manage time horizons automatically.

The problem with horizons in a holistic world

The concept of a time horizon is a mainstay of suitability. But what does it mean? Where does it fit into the planning process?

Including time horizon in a client’s investment objectives (as required by COBS 9.2.2) is designed to stop investors getting into things that, if they’re likely to get out of them too soon, would be too risky for them.

When ‘investment objectives’ were more closely aligned to product purchases, matching the term of an investment with the term of a singular objective made more sense. Now, however, it’s a relic of regulations that have evolved more slowly than the advice they’re there to govern. A holistic planning process calls for a more sophisticated interpretation of the rules than ticks in boxes provide.

Planning helps investors manage a fluid system of objectives, with shifting priorities, variations in each objective’s importance or how flexible costs or deadlines are. School fees happen at a set time or not at all, and the cost is fixed. Aspirational purchases that one could delay, or substitute a less-expensive alternative for, are more flexible.

In a planning-focused world (especially without forced annuity purchases), how should a time horizon be measured and managed? Is it linked to a product, a portfolio, an individual, or a family? Is it about time before review, moving manager, withdrawing in part, or in full?

A specific subset of investible assets may have a time horizon, but the notion of a single time horizon is nonsensical when applied (as it often is) to an investor’s holistic situation.

Investment horizons should be determined by when you need cash: how long do you have before your option to choose when to sell expires? When will you need to make withdrawals, and how large might they be? As a needed withdrawal comes closer, you will want to reduce risk to protect it. But by how much? And how quickly?

Each investor has multiple time horizons, because they have multiple withdrawal points and multiple goals. What matters is the weighted average of these horizons, a value that is in constant flux.

Managing time horizons is a question of capacity

Good risk capacity measurements manage time horizons automatically. Non-negotiable, time-limited goals with no control over cost reduce capacity (and therefore risk), insofar as the deadlines, certainty, and priority of future goals require it. For lower-priority, less-certain, or more distant goals, it is better to stay invested. Divorcing time horizon from the importance and flexibility of goals often leads to giving up future returns to protect assets for uncertain or unimportant withdrawals. This is unnecessary… and costly.

If a goal tabled for next year is low priority, it is better to stay invested and withdraw the money only if markets are still high in a year; if not, just postpone the goal.

There is, of course, an emotional side to this too. Our perception of ‘the right time to sell’ is rarely created by a calculator, and in times of stress, our emotional horizon can become dangerously distorted. Good investing is not only about determining our investment time horizons; it’s also about controlling our emotional one. About making sure we have the financial and emotional liquidity to choose when to sell.

Here, time is an input into a process, not a target to be aimed at. Fixing on a time horizon unhelpfully implies that goals are more static and more independent than they are in reality. Instead, investors need a means of managing the combined effects of overlapping, interrelated, and dynamic horizons; shortcutting suitability with a tick on a timeline is a cut too far.

Originally published in New Model Adviser on 12/11/2019.