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Tuesday, April 28, 2015

Your Investment Horizon Should Probably be Longer Than You Think and What it Means

The biggest obstacle to people investing in stocks is, understandably, the fear of losing money.  But the possibility is reduced the longer the investment horizon.

In my conversations with new clients, I find that most people think of their investment horizon as the time to when they plan on retiring.  Thus, a 50-year-old is thinking in terms of needing a nest egg in 15 years.  Which is, of course, the case; BUT he or she will need the nest egg to last not 15 years but another 30 years, potentially, past that.  Thus, most investors need growth for much longer than they typically think.

This is just considering the "I want to die broke" crowd.  Others have an explicit goal of leaving assets to their heirs.  Their horizon automatically extends a bit to account for younger heirs.

The good news along these lines is that risk, defined as the potential for a portfolio loss, is reduced the longer the investment horizon.  This is typically presented via a chart like this:

Source: Dana Anspach/ Money Over 55

Simply stated, the chart shows that holding stocks, which are most volatile as a sector over the short term, is actually quite safe the longer the investment horizon. The chart shows that, over the period examined, rolling returns for both the 15-year and 20-year periods were always positive as shown by the positive performance of their worst periods!

The significance of this is that the investment horizon is a key input in figuring out the percentage to invest in stocks. 

Behavioral finance tells us that our brains aren't really adept at thinking longer term; but, in this instance, we should remind ourselves of the data when setting up our investment strategy.  The ability to withstand short-term ups and downs of a roller coaster market pays off for those thinking in terms of a longer horizon.

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