Investment objectives are the result desired by the client from investing and should relate to the type of investments that will be purchased by the client. Be sure to articulate the time horizon in your statement of objectives. Time horizon is a critical parameter in the Know-Your-Client (KYC) process.
Time horizon is the period from now to when the client will need to access a significant portion of the money invested. It can be defined in absolute terms or in ranges that provide for a sufficient number of categories to assess the suitability of the products sold or investment strategies used. In principle, time horizon seems to be a simple concept. However, it gets tricky, because investment horizon can fluctuate based on evolving financial interests and other variables and an account can have more than one objective.
It is important to determine your time horizon before deciding what type of assets you should have in your portfolio. If you do not need your money for a long time, for example, decades, you can own a riskier mix of investments compared to a person who needs money within the next few weeks or months. Time horizon is not the only deciding factor, but it is a key one. It must be considered alongside and in concert with return expectations, cash flow needs and other factors. A longer time horizon means investors have more time to allow compounding of returns and ride through volatile markets assuming they have the financial capacity and risk tolerance to do so. During the 2008 financial crisis, many investors bailed out when markets tumbled because of fear or urgent need for cash for daily living expenses.
In many cases, an investor will have multiple goals with multiple time horizons at any given time. For example, you may have a Registered Retirement Savings Plan (RRSP) with a 30-year horizon, a Registered Education Savings Plan (RESP) for a child in grade school, and an open non-registered account to save for an upcoming vacation. You may even have multiple time horizons during retirement. You’ll need some short-term, lower-risk investments to generate income as well as longer-term higher-risk investments designed to provide growth and keep you ahead of inflation. To avoid misunderstandings, ensure your advisor understands your full time horizon profile. Be sure to update your profile as your situation changes.
Investment Firms distinguish between short-, medium- and long-term time horizons. Short-term investments are generally considered to have time horizon up to three years. The investor tends to have a low risk tolerance and should invest in guaranteed securities, such as GIC’s or high-interest savings accounts. Medium-term investments cover the period from 3 to 10 years.
Long-term investments are more often designed to be held for 10 or more years. With this time horizon, investors typically include a higher percentage of riskier, more volatile investments. For those investors with Registered Education Savings Plans, the time horizon is the point at which the child needs to enter university. In this case it is important to update time horizon at various points prior to university entrance especially those years immediately ahead of the planned use of the funds. Think of COVID-19’s abrupt impact on an education portfolio.
It is essential to understand the time horizon definitions used by your Firm before ticking off any time horizon boxes on forms.
The majority of advisors would suggest average 30-years-old investors to have asset allocation of a portfolio more heavily weighted in equities than that of someone who is close to retirement. Investor age is not the sole determinant of the duration of time horizon. For example, a middle-aged investor wanting to save money for a down payment on a house in one year would be investing with a one-year time horizon, even though her/his retirement is years away.
Some Firms define long term time horizon as greater than 3 years, making the recommendation of a purchase of a DSC mutual fund with a 6 year redemption schedule unsuitable. As another example, where a minimum time horizon has been established as a guideline for recommending leveraging, the time horizon on the KYC should be able to support that this criteria has been met.
A client with a long term time horizon, significant net worth, and income level may be able to withstand fluctuations in the market over the long term, which could lead to the conclusion that the client is medium to high risk or should invest a significant portion of his or her portfolio in riskier investments. However, if the client is unwilling or unable to accept that level of risk or is not comfortable with investing in risky or volatile investments, the KYC form should reflect the client’s decision and not the advisor’s opinion of what the client’s risk profile should be.
Be realistic. If you plan to retire at age 55 this may mean you will need to
significantly more risk for the potentially higher returns. If you are
seriously ill or at an advanced age, your time horizon likely shouldn’t be long
Never sign an incomplete KYC Form: A pre-signed form may allow an unscrupulous advisor to unduly increase your time horizon. Because every investment recommendation and every investment decision is based upon information contained on the KYC forms, any inaccuracy in the information necessarily taints a recommendation or decision made based on that information. Further, the uncertainty about time horizon impairs a Firm’s ability to ensure that all recommendations are suitable for you. An incorrect time horizon can lead to unsuitable investment recommendations and undue losses. In the event of a complaint, the Firm may point to your signature and deny your claim for restitution.
Think liquidity and cash flow: Your portfolio may have multiple time horizons and it needs to provide liquidity and certainty of liquidity to meet these liabilities as and when they fall due. This is particularly important for RESP’s and for retired people drawing cash for living expenses.
Joint Accounts: For joint accounts, certain KYC information, such as age and investment knowledge, is collected for each individual account holder. Annual income and net worth are typically collected for each individual or on a combined basis, as long as it is clear which method has been used. However, Investment objectives, risk tolerance and time horizon relate to the account and not each individual. That will influence the construction of the portfolio.
Now is a good time to revalidate your time horizon(s) and other critical KYC parameters with your Firm.