Concept
Time Horizon
Your time horizon is the number of years between today and the day you will actually need to spend a given pot of money, and it determines how much stock-market risk that money can sensibly carry far more than your nerve does.
Burton Malkiel, in A Random Walk Down Wall Street, makes a point that sounds obvious but changes how you plan. The risk of owning stocks is not a fixed property of stocks. It depends heavily on how long you hold them. In a single year, a broad stock index can jump sharply or fall by a third. Over twenty-year periods, the range of average yearly returns has historically been much narrower, and mostly positive. So the useful question is not "How brave am I?" but "When do I need this money?" Cash you need in eighteen months doesn't belong in stocks, because a crash could land right when you need it and force you to sell at the bottom. Retirement money twenty-five years out has time to ride through several crashes. One person can hold several horizons at once, so split your money by deadline, not by mood. History narrows the range of outcomes. It guarantees nothing.
A real-life example
Priya, 34, has $40,000. Of that, $15,000 is for her wedding next spring, and $25,000 is for retirement. She was about to put all of it into an index fund "because I'm young." Once she split it by horizon, the wedding money went into a high-yield savings account and the rest went into a broad index fund. When the market dropped 20% that autumn, the wedding budget was untouched. The retirement money still had three decades to recover.
How to use it
- 1List each pot of money next to the year you'll actually need to spend it.
- 2Keep money needed within about 3 years in cash or short-term bonds, use a blend for 3–10 years, and put 10+ years mostly in broad stock index funds.
- 3As a deadline approaches, move that pot gradually toward safer assets. Every pot's horizon gets shorter each year.