Investment horizon, wealth creation and goal setting

The time horizon of an investment is intrinsically linked to wealth creation. So, higher the time horizon (period of investment) of an investor, higher will be the wealth creation. Conversely, if the time period is less, the returns and, therefore, the wealth creation will also be low. This is because investments take time to grow, just as trees take time to bear fruit. One cannot plant a sapling today and expect to get the fruits tomorrow. The sapling has to be tended and nurtured every day so that it grows into a tree that will bear fruits someday. So it is with investments: you need to give it ample time to grow into a large corpus that will meet your financial goal someday.

When you give more time for your investment to grow, you get the benefits of the power of compounding and rupee cost averaging. The power of compounding comes into play over the long term as your earnings are reinvested, which enhances the returns every year in a compounded manner. If your investments are in equities or equity-oriented mutual funds, then the benefit of rupee cost averaging kicks in, which helps you to ride over market volatility as the ups and downs of the market are smoothened out in the long run. Hence, a long term time horizon leads to wealth creation. This may not be the case in the short term as market volatility may actually depreciate the value of your investment and lead to erosion of capital.

Depending on the financial goal, the investor has to decide on the time horizon needed to achieve the goal. So, if an investor wants to plan for children’s higher education or children’s marriage or wants to build a retirement corpus, the time horizon will have to be long enough. The corpus required for these three financial goals would have to be quite substantial, so the time horizon for investment would also have to be long enough, say, 10 years or more, to be able to achieve these financial goals.

On the other hand, if the goals are medium or short term, say, accumulating the amount of down payment for buying a house or a car (on a home/vehicle loan), investing for the short term (few months to a year or two) should be the preferred option as the amount of down payment would be needed after a few months or a year or two. Hence, in this case, the objective is not wealth creation and, therefore, more than return on investment, liquidity would be crucial for achieving these financial goals.