(LifeWire) - When you invest for retirement, your time horizon -- the time you have left before you have to draw on your money -- is one of the most important factors to take into account.
Why? Because your time horizon directly affects the amount of risk you should take with your portfolio.
If you have 40 years to save before retirement day, you can afford to load up on risky investments to boost your ultimate gains. If you lose big tomorrow, oh well -- you have 40 years to make it up.
If tomorrow is your last day at work, your biggest risk-taking days are over. You can't afford to lose what you soon must spend.
The Age Effect
In general, younger investors can afford to load their portfolios with stocks -- possibly as much as 90% in stocks for those with the longest time horizons, with the rest in bonds and cash. Stocks have historically outpaced inflation by a much wider margin than more conservative investments.
The eroding force of inflation is one of the biggest enemies of a long-term investment plan (along with investment expenses), so it makes sense to take the extra risk that potential stock losses represent.
Over time, the mix should move more heavily toward bonds and cash until investors within a few years of retirement have reduced their stock holdings to 50% or less. Stocks, for most investors, should not drop to zero at this point -- you still need some growth to pay for a lot of years of life -- but the relative stability of bonds and cash will minimize losses.
The Importance of Cash Reserves
Investors of any age should maintain several months' worth of cash as a cushion to cover emergencies.
You don't want a job loss or some other temporary setback to force you to sell your hard-won long-term portfolio.