Time Horizon

A client is saving at the same time for a home purchase in two years, university fees in twelve years, and her own retirement in thirty. The time horizon in her profile is best described as

1. A.two years, because the nearest of her goals must govern the portfolio as a whole.Wrong. Applying the shortest horizon to every dollar strands the retirement money in instruments that cannot grow.
2. B.thirty years, because the most distant of her goals must govern the portfolio as a whole.Wrong. That exposes the house deposit to a market decline it has no time to recover from.
3. C.the weighted average of the three, applied uniformly across the whole portfolio.Wrong. An averaged horizon corresponds to no actual goal and therefore mis-invests all three of them.
4. D.three separate horizons, each attached to the assets set aside for its own goal.Correct. Attaching the horizon to the goal is what lets each pool be invested for the date it must be spent.

Why: Time horizon is a property of a goal rather than of a client, and a client with several goals has several horizons running at once. Recording them separately lets the adviser reserve the near-dated money in instruments that will hold their value and invest the long-dated money for growth, which is impossible if a single horizon is imposed on the whole portfolio. Collapsing them into the shortest strands thirty-year money in cash, while collapsing them into the longest exposes the deposit to a market that may be down when she needs it. An average produces a horizon that matches none of the three goals.

A 78-year-old customer states a long-term growth objective and says she does not anticipate needing to draw on this money for ordinary living expenses. A representative recommends a non-traded program with an anticipated holding period well beyond what her actuarial life expectancy would suggest she is likely to need the investment to remain illiquid for. Does her stated objective and lack of an immediate cash need make the recommendation suitable?

1. A.Yes -- since she has no immediate cash need and states a long-term objective, the program's anticipated holding period is not a suitability concern.Wrong. A stated long-term objective and no immediate cash need do not, by themselves, establish that a holding period well beyond her realistic time horizon is suitable.
2. B.Yes, but only because non-traded programs are exempt from ordinary time-horizon suitability analysis for elderly investors.Wrong. There is no such exemption; time-horizon analysis applies to elderly investors the same as to any other customer.
3. C.No -- her age and the mismatch between the program's anticipated holding period and her realistic investment horizon raise a suitability concern of their own.Correct. A program's expected life cycle running well beyond an investor's realistic time horizon is a distinct suitability issue, separate from whether she currently needs the cash.
4. D.No, but only because she failed to disclose her actuarial life expectancy directly to the representative.Wrong. Life expectancy doesn't need to be separately disclosed as a figure; her age itself is enough to raise the time-horizon question relative to the program's anticipated holding period.

Why: A stated long-term objective and no immediate cash need address only part of the picture. Time horizon has to be evaluated in light of the customer's own likely investment horizon, and for an investor at this age, a program whose anticipated holding period runs well beyond a realistic time horizon for her raises a suitability concern independent of whether she currently needs the cash for living expenses. Her professed comfort with a long time horizon does not itself establish that a program lasting longer than her own realistic horizon is suitable.

A client has just sold the private company that represented most of her net worth and now holds the proceeds in cash. In updating her profile, the change that matters most is that

1. A.her time horizon has shortened, because she no longer receives income from the business.Wrong. Losing an income stream does not move any of her goals closer in time.
2. B.her risk capacity has changed, because one illiquid holding has become diversifiable liquid wealth.Correct. Composition of the balance sheet is what capacity is read from, and it has changed fundamentally.
3. C.her risk tolerance has increased, because the successful sale proved her judgement sound.Wrong. A favourable outcome is not evidence about her willingness to bear a future loss.
4. D.her required return has fallen, because the sale proceeds are now safely in hand.Wrong. Required return is set by her goals and horizon, and the sale changed neither of them.

Why: A life event changes a profile by changing an underlying fact, and here the fact that changed is the composition of the balance sheet. What had been a single illiquid holding, concentrated in one business and correlated with her own labour, is now liquid wealth that can be diversified and drawn on, which raises her capacity to bear market risk in a way nothing else in the profile has done. Her goals, her horizon and the return she needs are all unchanged by the transaction. Whether she should actually use the additional capacity is a separate question, answered by her goals and her tolerance rather than by the sale.

A client retiring next year tells her adviser that her time horizon is therefore one year. The adviser should explain that

1. A.she is right, since the accumulation period ends when the salary stops arriving.Wrong. Accumulation ends but the money still has to last, which is what the horizon measures.
2. B.her horizon runs for as long as the portfolio must support her, which is her remaining lifetime.Correct. The horizon is defined by how long the assets must work, not by the date the salary stops.
3. C.her horizon is now indefinite, so the allocation should be as aggressive as tolerance permits.Wrong. An open-ended horizon does not remove the need to fund the next few years of withdrawals.
4. D.horizon stops mattering once withdrawals begin, with liquidity governing in its place.Wrong. Liquidity governs the near-term spending and horizon still governs the decades funding it.

Why: Retirement ends the accumulation period but not the investment horizon, which runs for as long as the portfolio has to support the client and, where a survivor or a legacy is involved, longer still. A client with decades of spending ahead needs the portfolio to keep growing through most of that period, so treating the retirement date as the end point produces an allocation far too conservative to last. What the retirement date does introduce is a liquidity requirement for the first few years of withdrawals, which is met by reserving that money rather than by de-risking everything. The two considerations coexist, which is why near-term spending and long-term funding are held in different pools.