One of the fundamental building blocks of any investment plan is a clearly defined time horizon. Most importantly, it is crucial to understand when drawdowns will be made. Typically, a longer time horizon allows for greater risk appetite, whilst a shorter horizon allows for less. In other words, your time horizon usually informs your allocations towards growth assets, such as equities, or defensive assets, including cash.

An analysis of returns data can help us better understand how time horizons influence investment allocations.

In the short term, growth assets produce volatile returns, with sharper increases and pull-backs than defensive assets. But over the long term, growth assets tend to follow a higher returns trajectory.

A longer time horizon allows us to look through the noise and focus on overarching patterns. This makes an allocation towards growth assets less speculative, and means higher levels of certainty regarding outcomes.

In a way, this is similar to the holiday planning process: If you are looking for a warm beach holiday in Hermanus, you will probably book during the peak summer months. Although this doesn’t guarantee that you will have great weather, we know that it’s likely to be significantly warmer than in winter. You are basing your decision on long-term climate trends to give yourself the best possible chance of a good outcome.

The same can be said for cash and equities, as shown below. If you want to earn great returns, but need to draw on your investment in one year’s time, the range of outcomes may simply be too large to risk being invested in equities. However, if you only require access to your cash in 10 years, and are looking to maximize returns, the range of outcomes skews in your favour – just like a mid-summer beach holiday booking.

Cash and equity "real" range of returns

When we design our multi-asset funds, we do so with specific time horizons and return objectives in mind. The key principle is to maximize the investor’s chance of achieving their desired return over the specified time horizon.

To illustrate this, we looked at all possible asset class combinations within the (ASISA) South Africa Multi-Asset Low Equity and High Equity Category to show how asset allocations can target specific outcomes over defined time horizons. In summary, the short-term (one year) range of outcomes appears to be wide and has too much downside risk for most investors. However, over the appropriate time horizon, the range of outcomes narrows and is skewed to the upside. There is a clear move towards certainty of outcomes and away from downside risk.

SA low equity category targeting
SA high equity category targeting

The next challenge is a behavioural one. An investor may make an appropriate asset allocation for a three-year time horizon, but then feel the urge to shift into defensive assets after just one year because of market volatility. In such cases, it is important to avoid the trappings of loss aversion and recency bias (the fear of losing one’s money and the belief that recent events will be replicated into the future, even though long-term economic trends tell us otherwise). These behavioral challenges are often solved by knowledge and sound financial advice.

At CoreShares, we believe in focusing on the long-term fundamentals of asset class returns, keeping investor goals at the centre of the investment solution, and spending time in the market, rather than trying to time the market. We also believe that you shouldn’t be surprised if you spend your days huddled by the fire on your ‘beach’ holiday in Hermanus in July!

Learn more about how our multi-asset funds can help you reach your goals:

Did you enjoy this article? Sign up to our monthly CoreScores newsletter for thought leadership and fund updates: