Question

What are the main things to consider before making such an investment when one has a three year horizon and the other has a 5 year time horizon

Answer 1

Solution:-

While making an investment there are various factors that are required to be considered, including but not limited to expected returns, required returns, risks involved, liquidity, taxability, etc.

However, when it comes to analyzing an investment opportunity from the perspective of investment horizon that the investor has, following are the crucial factors:

• The shorter the time horizon the riskier it becomes financial markets can be very uncertain and volatile on short to medium term, while they tend to eb far more stable in the longer term. If an investor has a 3 year horizon he must not invest in risky securities such as small cap stocks because they can generate loss for the investor by staying undervalued for a long period of time. On the contrary, if the horizon is 5 years, the investor can afford to invest in riskier securities knowing that the investments would tend to resport to their fundamental values over a longer period such as 5 years
• Another crucial factor to consider is liquidity. If an investor has a 3 year horizon, he must analyse if he will be able to liquidate his investment in 3 years time or not. The same rule goes for a 5 year horizon. The factors to be looked at include the terms of the investment, market liquidity, etc
• Taxability is another crucial factor while looking at investment opportunities with different time horizons. The investments with different time horizons may be taxed differently and therefore while looking at opportunities with 3 year and 5 year horizons, one must consider the difference in their taxability of the profits
• The expected per annum return also differes for investments with different time horizons. We can't expect same per annum returns from an investment of 2 years with one that of 30 years. This is due to factors such as economic growths, inflation rate changes, interest rate changes, etc Thus, while looking at a 3 year and 5 year horizon investmnents, one must take into account the variation in the expected rate of returns relative to their respective risks