Investing

Investing for Retirement: Time

Introduction

Time is transformational. The longer the time that you hold your investments, the closer your portfolio’s actual returns will approximate their expected average. If your investment time frame is short, then higher return investments may be too risky due to variation in their near-term returns. But, if your investment time is long-term (i.e. 20-40 years), then you can consider higher-return, riskier investments because the variation in your actual returns will more closely approximate their expected return.

This explains why younger investors with very long time horizons are better served by investing overwhelmingly in equities. Conversely, investors closer to or in their retirement years may prefer bonds or even cash. In the short term, risks are highest for stocks. In the long term, risks are lowest for stocks, particularly after adjusting for inflation.

Impact of Your Time Horizon on Expected Returns

If you review a portfolio of solely U.S. equities each year, you will see significant variation in returns:

[INSERT 1 YEAR TIMELINE CHART]

However, if you aggregate returns over a five year period (as a proxy for a dollar cost averaging strategy), then you see significantly less variation in your portfolio’s returns.

[INSERT 5 YEAR TIMELINE CHART]

The longer your timeline–10, 20, and 30 years–the less variation in your portfolio’s returns.

[INSERT 10 YEAR TIMELINE CHART]

[INSERT 20 YEAR TIMELINE CHART]

[INSERT 30 YEAR TIMELINE CHART]

Now, let’s rearrange those results into a probability distribution:

[INSERT 1 YEAR PROBABILITY DISTRIBUTION CHART]

[INSERT 5 YEAR PROBABILITY DISTRIBUTION CHART]

[INSERT 10 YEAR PROBABILITY DISTRIBUTION CHART]

[INSERT 20 YEAR PROBABILITY DISTRIBUTION CHART]

[INSERT 30 YEAR PROBABILITY DISTRIBUTION CHART]

As you can see, the longer your timeline, the more that your actual portfolio returns will mirror their expected returns.

Summary

Your biggest long term concerns are inflation and when you need to sell (your time horizon). Therefore, the proper degree of risk that you should assume is a function of when you need access to your funds. As you get closer to needing to spend your funds, your asset mix should shift from risky to riskless assets:

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Updated on December 25th, 2018