If you have spent any time in consultation with an investment firm/advisor, you will have had some experience with what the industry refers to as the Know Your Client (KYC) form. It asks questions about your investment knowledge, income, net worth, risk tolerance and time horizon. Some of the questions are straightforward since they are based on real, quantifiable data: “How much do you make?” Others are much more ambiguous: “What is your risk tolerance?” All of these questions are important because the document is generally the basis from which an investment counsellor guides clients through the construction of their investment portfolios. One of the most confused and poorly understood is the question about investment time horizon. Hopefully I can add some insight.
The question typically asked on a KYC form with regards to timeframe is: “What is your investment time horizon?” Your options are:
- Short term – typically less than five years
- Medium term – typically between five and 10 years
- Long term – typically understood as more than 10 years
Your task is to tick the one box that best suits your investment goals. If the goal is finite (like buying a house in two years), the answer is easy – tick off that short-term box. But often the time horizon is not so simple to define. In the case of retirement, for example, the goal might start at a specific time (when I turn 65) but span 20 or 30 years. With this goal, the question becomes impossible to answer with one tick because the objective is multi-staged. If not fully understood, this “trick question” can lead to incorrectly specified KYCs, poorly constructed portfolios and a failure to reach your retirement objective. Scary stuff!
Let’s look at an example: Jack and Jill are planning to retire in four years, have an investment portfolio of $1 million and plan to redeem a sustainable $50,000 per year from their portfolio when they retire (more on why this is a sustainable withdrawal rate in later posts). Given the choice between short term, medium term and long term, Jack and Jill (along with most investors) will probably choose the short-term option due to their approaching retirement date. However, this is not the most appropriate answer to the question. The couple’s time horizon is actually a combination of all three options. Since they will require $50,000 from their portfolio in four years’ time, this portion of their portfolio has a short-term time horizon. $250,000 of their portfolio will be required for cash-flow purposes over the following five years and should be considered medium term ($50,000 per year x five years). And the large majority of their portfolio ($700,000) will not be required for 10 years or more. Since the majority of the portfolio will not be required for more than 10 years, and even though Jack and Jill are only four years away from retirement, their investment time horizon remains long term.
The next post on the topic will delve into how to construct your portfolio based on a multi-stage time horizon.
This post is presented for illustrative and discussion purposes only. It is not intended to provide investment advice and does not consider unique objectives, constraints or financial needs. Under no circumstances does this post suggest that you should time the market in any way or make investment decisions based on the content. Select securities may be used as examples to illustrate Burgundy’s investment philosophy. Burgundy funds or portfolios may or may not hold such securities for the whole demonstrated period. Investors are advised that their investments are not guaranteed, their values change frequently and past performance may not be repeated. This post is not intended as an offer to invest in any investment strategy presented by Burgundy. The information contained in this post is the opinion of Burgundy Asset Management and/or its employees as of the date of the post and is subject to change without notice. Please refer to the Legal section of this website for additional information.