A broken heating system does not wait for the stock market to recover. If the 5,000 euros needed for the repair are invested in an asset that has temporarily suffered a book loss of 15%, only 4,250 euros may be left at the worst possible moment. The tradesperson’s bill will not be any smaller. For money that will not be needed for 20 years and is intended for retirement provision, such a negative fluctuation is not a problem; on the contrary, anyone saving through a monthly savings plan benefits from lower prices and therefore receives more units, whose value still has enough time to grow before the later withdrawal.
The investment horizon determines how much time is available for a recovery and how much risk a financial goal can tolerate. Proper planning for all areas of life makes many things easier in everyday financial life.
The investment horizon is more than a number of years
The investment horizon does not simply describe the time that has passed since an investment was started. Rather, it describes the period until the moment when a particular amount is needed. For a one-off goal, the earliest planned date of use is what counts. With a savings plan, every contribution even has its own investment horizon. This distinction prevents a common error in thinking that can cause worry in everyday financial life instead of the relief actually hoped for or even freedom.
While the portfolio can be intended to run for more than 20 years, another part of the money may already be due in two years for a renovation or simply be intended for an unplanned expense. The entire portfolio of assets must therefore not be treated as if it would remain untouched for two decades.
Every investment must also take the return triangle into account, in which three goals compete with one another: security, liquidity and return. Security means that the value fluctuates as little as possible. Liquidity means that the money is available when it is needed, while return describes the opportunity to increase wealth or at least preserve purchasing power. All three characteristics cannot be maximised at the same time.
| Period | Typical purpose of the money | What matters at the date |
|---|---|---|
| 2 years | Unexpected expenses: repairs, a car or a tax payment | Flexible access and as little loss of value as possible. A sale at a loss must not be necessary. |
| 5 years | A larger purchase, equity or education | A fixed date requires more stability. A flexible goal leaves more time. |
| 20 years | Retirement provision and long-term wealth building | Interim declines are more tolerable as long as no withdrawal is due. |
Risk tolerance and risk capacity are also not the same thing. Risk tolerance describes which fluctuations someone can withstand psychologically. Risk capacity, by contrast, describes what loss a person’s financial situation can absorb. Someone may be able to tolerate falling prices calmly, but the bill that is due may still be difficult to pay in the end.
Liquidity is also often confused with a quick sale. A security can be sold on a trading day, but the proceeds are not determined until after the sale. Anyone who needs the money on a specific date and at a set time needs not only a buyer, but also sufficient value at the right moment.
2 years: Repair money must remain available
Money for a broken washing machine, a car, a new heating system or an unexpected dental bill has a different purpose from money intended for retirement provision. It is not supposed to grow as much as possible, but to absorb financial uncertainty without having to take out a loan or sell a portfolio at a loss.
This may seem insignificant at first glance, but that is exactly the purpose: a reserve has to work in an emergency, not look good in a long-term return statistic. If 5,000 euros are earmarked for a repair and the value falls by 15% shortly before the bill arrives, 750 euros are missing. A gap arises that has to be closed from ongoing income, a loan or other assets.
For money needed in the short term, a value that is as stable as possible is often more important than the prospect of a higher return. This does not mean that such investments are risk-free. Inflation can reduce purchasing power. For a short and fixed purpose, however, this loss of purchasing power has to be weighed against the risk of selling at an unfavourable time.
The most important amount is not always the entire reserve. Some expenses can be postponed, while others cannot. A broken heating system in winter can hardly wait. A new car or a larger trip, on the other hand, may be planned differently under certain circumstances.
5 years: A fixed date tolerates less fluctuation
A period of five years lies between a short-term reserve and long-term wealth building. That is precisely why the most incorrect precautions are taken here. Five years is not long enough for a highly volatile investment, but it is not too short for every form of risk either.
A planned property purchase with a fixed date has different requirements from long-term wealth building. If the money is needed as equity in five years, a fall in prices shortly before the purchase can jeopardise the financing. The purchase price will not wait for better market conditions, and the bank will not replace missing equity with a long-term hope of returns.
The situation is different if the goal is flexible: if the purchase is postponed by two or three years in an unfavourable market environment, there is more time for a recovery. An existing safety buffer can also change the situation. The volatile portion may then contain only money whose loss or delay does not immediately destroy the actual goal.
For investment recommendations, the European Securities and Markets Authority (ESMA) requires a comprehensible connection between a person’s investment horizon and the recommended holding period of a product. An investment horizon of five years should therefore be linked to another characteristic: the flexibility of the goal. A fixed date reduces the tolerable risk range, while a movable date increases it. Another question is whether the full amount will be needed at that point or only part of it.
For medium-term goals in particular, time staging is worthwhile. Money needed in the first year after the target date needs more stability than money that will only be used later. In this way, an apparently uniform five-year goal becomes a series of smaller periods. The earliest of them determines how much fluctuation the most important part of the money can withstand.
20 years: Time helps, inflation remains
With an investment horizon of 20 years, the balance changes considerably: a temporary fall in prices does not automatically become a loss if the money does not have to be sold. Several market phases and entire cycles can be experienced. The risk then consists not only in falling prices, but also in building up permanently too little purchasing power.
BaFin points out that a long investment period has historically increased the chance of more stable return development. This must still not be regarded as a guarantee, but it shows that a long period offers more possibilities for sitting out interim fluctuations and ultimately only increases the probability of coming out of the investment with a gain. For long-term goals, broadly diversified, volatile asset classes therefore play a greater role. Diversification reduces additional risks from individual companies or borrowers.
The difference between a temporary decline and a permanent loss must remain clear: broadly diversified assets may recover after a weak phase, but they do not have to do so within any arbitrary period. An individual holding, by contrast, can lose value permanently or fail completely. Time does not protect against every mistake.
Inflation also works continuously against people who hold money, buffers and assets, and has a considerable effect on purchasing power when measured over decades. Money that remains stable in nominal terms can lose value in real terms. The investment horizon does not necessarily end with retirement. As soon as the first withdrawals begin, a new, shorter period starts for the amount needed at each point. Money for the first years of retirement must not be treated in the same way as money that will only be needed ten or 15 years later. A fall in prices during the accumulation phase has different consequences from a fall immediately before a withdrawal.
Every household needs several money pots
A household can set aside money at the same time as an emergency fund, a larger buffer or retirement provision. It is difficult to establish a fixed percentage allocation, however, and it is always highly individual. The structure depends on income, debt, reserves, obligations and specific goals. Three points should be reviewed regularly: first, the earliest point at which the amount will be needed. Second, whether this date can be postponed, and third, the financial consequence of a loss in value: can the expense still be paid, or would a loan have to be taken out?
When life changes, the investment horizon of the money pots changes as well. A planned house purchase may suddenly become imminent, while uncertainty at work may require additional liquidity to bridge a period without income. An investment that was long-term yesterday may already be medium- or even short-term tomorrow.
Money for a goal may be treated differently from money for the future
A reserve for repairs may be boring, but it must remain available at all times and fulfil its purpose. Retirement provision, by contrast, may fluctuate considerably because there is enough time for a recovery and inflation cannot simply be ignored. The investment horizon does not determine the future return, but only how much time the money has to cope with fluctuations. The closer the date of use approaches, the less the result may depend on a favourable year in the stock market.
Anyone who separates money according to these periods does not need a one-size-fits-all plan for all assets. It is enough to give each amount a clear purpose and an appropriate period.
