Stop Stealing From Your Future Self: The Time Horizon Test

I was a nice guy once. It cost me $2,000 and the last of my savings. That $2,000 hit completely cleared my emergency fund. Why? Because the money I needed for ‘now’ wasn’t there. That’s the real-world consequence of a concept called Temporal Discounting Bias.

Short, Medium and Long-term savings, where do you even start? First question: Do you know what Temporal Discounting Bias “TDB” is? For the sake of this article, let’s pretend you don’t. David Laibson performed a study published in 1997 called “Golden Eggs and Hyperbolic Discounting” (cool name, right?). What David found is that the value placed on rewards decreases very rapidly for small delay periods and then falls more slowly for longer delays.

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If I offered you £200 today or £220 in one month, how much am I paying you? Now, let’s say I offer you £200 in one year or £220 in one year and thirty days, how much am I paying you? Evidence shows that present rewards are weighted more heavily than future ones. Once rewards are very distant in time, they cease to be valuable. Most people would take the £200 now, but the £220 when it’s a year plus away.

Now, remember the above; it will have relevance further down (I promise).

Let’s Get Into It

Short, medium, and long-term savings depend on the time horizon when funds are needed. While that is relatively straightforward, the time horizon can sometimes be confusing to people. Common concerns for confusion:

• What is the correct length of time
• What types of things should be put into a time horizon
• Where do I save my funds
• TDB

Like all personal finance choices, you should take a moment to consider the Goal before adding time to it. Once your goals are decided, the next step is to determine the suitable level of Risk and the appropriate Savings Vehicle. Only you will know what your goals and risk tolerance are, so don’t rush this step.

Overview of Time Horizons, Risk, and Focus

Risk Profile: What you should consider when determining the acceptable level of investment volatility based on the Goal Type, ensuring safety for imminent needs and growth for future ones. This entire savings structure aligns with the 20% Savings & Debt portion of the 50/30/20 Budget Rule, designated for money that secures long-term financial health.

Short-Term Savings

Near future spending. The most important aspects for short-term savings are safety and guaranteed access to cash. I’ll give you an example. In my younger years, I had a Jeep. While on my way, I stopped to help a fellow Jeep owner who had broken down on the side of the highway. I had some rope and gave him a tow to the nearest exit. While I thought I was doing a kind gesture, it turns out that in the process, my rear axle snapped (found out by the time I got home). This “kind” gesture cost me $2,000 to fix my Jeep, while my emergency fund consisted only of $1,400. Yup, completely cleared my minuscule emergency fund (every cent). This forced me to rethink how much should be in an emergency fund.

Common Short-Term Goals

• Funding an Emergency Fund (covering 3 to 6 months of expenses).
• Saving for a major expense, such as a large appliance or a holiday.
• Paying off high-interest debt (like credit cards), which in most cases should be prioritised before significant long-term investing begins.

Recommended Resources and Vehicles

As these funds are sometimes required imminently, they need to be risk-free and have quick access, i.e., Cash/Liquid Accounts. Look for something that can give you some interest (screw inflation).

Fringe Information and Risk

• Short-term savings options, such as easy-access savings accounts and CDs, provide liquidity but tend to lag behind inflation in terms of returns.

Medium-Term Savings

Future spending, but not too far in the future. As the time horizon has expanded, so should your degree of risk (to a small degree); however, stability is key. I have a cute example, something out of a Pixar movie. A friend of mine started dating this wonderful girl. Very quickly, he came to the boys and told us he was going to marry this girl (yeah, yeah, we said). He wasn’t joking, though. Respectful, this girl enjoys the finer things in life, and he knew pretty quickly that she would want a big wedding. He started saving early, five years before their wedding, during their dating life. Way before I assume she considered marrying him. Long story long, they had a huge, amazing wedding, probably the best one I’ve been to yet.

Common Medium-Term Goals

• Saving for a down payment on a home.
• Funding major purchases like a car or a home renovation.
• Saving for a child’s private school tuition, college/university, or a wedding.

Recommended Resources and Vehicles

In this time horizon, we want to juggle the impact of inflation vs exposing our capital to severe volatility. I personally have a low risk tolerance for this term and tend to move around from one HYSA to another. You can also approach a mix of stocks and bonds, potentially split as 50% Safe Cash / 50% Conservative Investments.

Fringe Information and Risk

• The extra debt payments beyond the required minimum for obligations like mortgages or US student loans are considered part of the future-focused 20% savings pot, effectively prioritising wealth building and liability reduction over this horizon.
• Bonds, often included in medium-term portfolios, are susceptible to inflationary risk (where fixed coupon rates erode due to rising consumer prices) and interest rate risk (where rising rates reduce bond values).

Long-Term Savings

Decade or more! A time span where the dangerous influences of Temporal Discount Bias become catastrophic (circling back). I could cite countless examples of individuals reaching retirement age with next to nothing, victims of prioritising today over tomorrow. Even if you genuinely love work and feel you could do it to the day you die, there’s no certainty that you will be able to do that. MY BIGGEST fear/worry when it comes to others’ personal finance is when the time comes to “hang up the boots”, you find your financial safety net is non-existent. Do not fall into the trap of TDB and plan for the future (a small amount of consistency will go a long way).

Common Long-Term Goals

• Retirement (the most common long-term investment).
• Saving for a child’s college/university education.
• Building a significant investment portfolio or paying off a mortgage early.

Recommended Resources and Vehicles

The easiest resource for long-term savings is the Stock Market, which can offer some of the highest potential for growth with little barrier to entry. As the time horizon is much longer, it means you can take greater risks in exchange for a greater reward. Before investing, consider how long the time frame is. For some, it may be 30 years, but for others, it may be 10 years. While portfolios with a much longer timeframe can take a more aggressive approach, for example, 90% stocks. A 10-year horizon, for example, may want to have a 70/30 stocks and bonds split (depending on your risk appetite). Regardless, a long horizon provides time to recover from any short-term downturns.

Investment Focus: The above accounts are typically used to hold higher-risk/higher-reward assets, such as stocks, Index Funds, and ETFs (Exchange-Traded Funds).

Fringe Information and Risk

• The “magic“ word of Compounding of long-term investing, growth serves as the fuel for future growth, allowing small initial savings to grow exponentially. The ability to stick around long enough for compounding to work is critical for success.
• Long-term goals utilise investments with low liquidity (i.e. can’t pull money out at all and/or may face withdrawal penalties), which is acceptable because the funds are not needed immediately.

While the time horizons are concrete in terms of short, medium and long, your personal discussion on what to contribute to each pot allocation really comes down to you. Put some serious thought into the medium-term (save for that big holiday, it will be worth it) and set up long-term savings now. I like to use the “set it and forget it“ (long-term). There is nothing wrong with wanting things now, but avoid the pitfalls of TDB.

If you are looking for how to begin budgeting, check out the 50/30/20 Budget Rule. You will find the starting blocks on how to begin building your budget, which can then segue nicely into deciding on short-, medium-, and long-term personal financial goals.

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