Volatility of returns decreases and outcomes become more predictable as the holding period lengthens

 The Volatility of Returns by Holding Period

 (Stocks, Bonds and 60% Stocks / 40% Bonds Portfolio)

This image presents a compelling visual argument for long-term investing by showing how volatility decreases and outcomes become more predictable as the holding period lengthens.

Key Analysis & Observations:

1. The Central Message: Time Smooths Volatility

• 1-Year Rolling Returns: Extreme variability (stocks: -29% to 43%, bonds: -20% to 30%). This represents the "noise" and emotional challenge of short-term investing.

• 5-Year Rolling Returns: Range narrows significantly (stocks: -2% to 24%). Negative periods become less severe and less frequent.

• 10-Year Rolling Returns: Range tightens further (stocks: 6% to 18%). No 10-year period lost money in stocks during this 75-year timeframe.

2. Asset Class Comparison

• Stocks (S&P 500): Highest long-term return (11.6%) but with greatest short-term volatility.

• Bonds: Lower return (5.2%) with less extreme swings, though still significant 1-year volatility.

• 60/40 Portfolio: Excellent compromise—captures most equity upside (9.4% return) while dramatically reducing downside risk across all time horizons.

3. The Compounding Power Demonstrated

The ending portfolio values starting from $10,000 in 1950 are staggering:

• Stocks: $895,754 (89.5x growth)

• 60/40: $600,708 (60x growth)

• Bonds: $276,382 (27.6x growth)

This visually reinforces why accepting stock market volatility pays off over decades.

4. Behavioral Finance Implications

The chart essentially argues against market timing:

• In any single year, you might experience -29% returns

• But if you wait 10 years, the worst-case was still +6% annualized

• This explains why "time in the market beats timing the market"

Critical Commentary & Context:

Strengths of This Presentation:

1. Effective Data Visualization: The shrinking ranges perfectly illustrate the diversification benefit of time.

2. Historical Perspective: 1950-2024 covers multiple cycles (inflationary 70s, dot-com bubble, 2008 crisis, COVID).

3. Practical Application: Directly shows why retirement investors should focus on decade-long horizons, not quarterly statements.

Important Caveats & Limitations:

1. Survivorship Bias: U.S. markets were exceptionally successful post-WWII. This isn't guaranteed globally.

2. The "End Date" Problem: 2024 is near market highs. Starting in 1929 or 2000 would show different 10-year outcomes.

3. Interest Rate Regime: The bond bull market (falling rates from 1980-2020) boosted returns. Future bond returns may differ.

4. Psychological Realism: While 10-year returns were always positive, experiencing 5+ years of poor returns tests investor discipline.

Portfolio Construction Insights:

• The 60/40 portfolio shows remarkable efficiency: capturing 81% of stock returns with dramatically reduced risk.

• For most investors, this supports classic balanced portfolio construction.

• The data suggests rebalancing discipline during bad years would have been rewarded.

Conclusion & Takeaways:

This chart delivers a powerful, evidence-based narrative: Volatility is the price of admission for long-term growth.

For investors:

1. Holding period dictates risk more than asset allocation alone

2. Time horizon should match portfolio construction (money needed in <5 years shouldn't be in stocks)

3. The 60/40 portfolio remains remarkably resilient across market conditions

4. The biggest risk may be overreacting to short-term volatility rather than the volatility itself

The most striking visual is the transformation of stocks from "high-risk gamble" (1-year view) to "reliable wealth-builder" (10-year view)—a fundamental lesson in investment perspective.

It's About Time in the Market, Not Timing the Market. Long-term investing dramatically reduces "sequence risk."

 

Simple Summary of the Chart's Main Points:

1. Short-term stock investing is risky. In any single year, you could make over 50% or lose over 25%.

2. Long-term stock investing is much safer. Over every 10-year period from 1950-2005, stocks made money (at least 4.3% per year).

3. Time smooths out the ups and downs. The longer you hold stocks, the narrower the range of possible outcomes becomes. Over 20 years, the worst case was still a gain of 6.5% per year.

The Bottom Line for You:

• Don't invest money in stocks if you'll need it within 5 years. The risk of a loss is too high.

• Do invest money in stocks for goals 10+ years away. History shows patience has been consistently rewarded.

• Stay calm and stay invested through short-term downturns to capture the long-term trend.

=====

Based on the chart above, here is an analysis, discussion, and commentary on the range of annual returns for U.S. common stocks from 1950 to 2005.

Analysis: What the Chart Shows

The chart plots the maximum, median (or average), and minimum annualized returns for common stocks (likely the S&P 500) over holding periods ranging from 1 year to 25 years.

Key Data Points:

• 1-Year Holding Period: Returns are extremely volatile, ranging from a high of +52.6% to a low of -26.5%. The median is a solid +12.6%.

• 5-Year Holding Period: The range narrows significantly. The worst 5-year period still had a positive annualized return of +1.2%.

• 10-Year Holding Period: The minimum return becomes +4.3% per year. There has never been a losing 10-year period in this 56-year span.

• 20-Year Holding Period: The range tightens further. The worst 20-year period delivered +6.5% annualized, while the best was +17.9%. The median is +10.7%.

• 25-Year Holding Period: Volatility nearly disappears. The worst-case scenario was +7.9% annualized, and the best was +17.2%. The median is +11.1%.

Discussion: Key Insights and Implications

1. The Power of Time in Reducing Risk (Volatility): This is the chart's central, most powerful message. Short-term investing in stocks is very risky—you could experience spectacular gains or severe losses. However, long-term investing dramatically reduces "sequence risk." As the holding period lengthens, the range of possible outcomes narrows, and the worst-case scenarios become markedly better.

2. The Persistence of Equity Risk Premium: Across all time horizons, the median return is consistently positive and relatively stable (between ~7-12%). This illustrates the historical equity risk premium—the extra return investors have received for bearing the increased risk of stocks over "safer" assets like bonds.

3. "It's About Time in the Market, Not Timing the Market": The chart visually argues against market timing. A bad single year (-26.5%) is devastating, but if you stay invested, long-term results smooth it out. Missing the best days by trying to time entries and exits can cripple long-term returns, which is a related classic lesson this chart supports.

4. The Critical Importance of the Starting Valuation: The worst 20-year period (+6.5% annualized from 1961-1981) began at a time of very high valuations (the "Nifty Fifty" bubble era). The best periods often followed times of panic or low prices (e.g., post-1974 stagflation, early 1980s). This reminds us that while time mitigates risk, the starting price you pay still matters profoundly for your ultimate return.

Commentary: Strengths, Caveats, and Modern Context

Strengths of the Chart:

• It is one of the most effective visual tools for teaching the principle of time diversification.

• It provides a strong, data-driven argument for patient, long-term investing and for maintaining a strategic asset allocation through market cycles.

• It helps manage investor psychology by showing that even historically bad periods were recovered from with time.

Important Caveats and Limitations:

1. Survivorship and Period Bias: The data covers 1950-2005, a generally prosperous period for the U.S. economy and markets, featuring the post-WWII boom, the tech revolution, and falling inflation. It excludes the Great Depression (where 20-year returns were negative) and the Global Financial Crisis of 2008 (which would worsen the 1-year and 5-year minimums).

2. Past Performance is Not Guaranteed: The chart shows history, not prophecy. There is no guarantee that future 20-year periods will always be positive, though the long-term trend of economic growth makes it a reasonable expectation.

3. Ignores Inflation and Taxes: Returns are nominal (not adjusted for inflation). The "real" return (after inflation) is what truly matters for purchasing power. Taxes on dividends and capital gains also reduce net returns.

4. Assumes a "Perfect" Investor: The analysis assumes an investor bought a broad index and held it without emotion, through every bear market, and never sold in panic—which is harder in practice than in theory.

Modern Context (Post-2005):

• Including data through 2023 would add the 2008-09 Financial Crisis (a severe test) and the long bull market that followed.

• Despite the 2008 crisis, a 10-year period ending after the recovery (e.g., 2009-2019) would still have shown strong positive returns, likely upholding the chart's thesis.

• The 2022 bear market and the COVID-19 crash (2020) reinforce short-term volatility but also the speed of potential recoveries.

Conclusion

This chart remains a classic and powerful illustration of a fundamental investing truth: time is an investor's greatest ally. It convincingly shows that while stock markets are inherently volatile in the short run, their long-term upward trend has, historically, rewarded disciplined investors. The primary takeaway for an individual investor is to align their equity exposure with their time horizon. Money needed in less than 5 years has no business being heavily in stocks, while money for retirement 20+ years away should harness this long-term smoothing effect.

However, it must be viewed as evidence of a historical principle, not a guarantee, and should be considered alongside diversification across asset classes (bonds, international stocks) and an understanding of current market valuations.

Know your Investment Profile

Your investment profile

Define your investment profile by identifying:
1.  Your goals and constraints
2.  Your risk ability and tolerance
3.  Your cognitive biases and their impact on your emotions.


Profiling:  everyone is unique

Differences go beyond the level of wealth and stem from:

• 1.  Age
• 2.  Education
• 3.  Phase of life
• 4.  Profession
• 5.  ...

Financial situation as the core of your profile

1.  A very wealthy person with relatively little planned expenses

• Will be able to take considerable investment risk, as you have enough funds aside to absorb potential losses.
• Will be said to have a "high risk ability"

2.  A person with limited wealth and a large part of his assets reserved for financial commitments:

• Can only take limited investment risk, as he lacks funds to cover potential losses
• Will be said to have a "low risk ability"

Ranking the objectives is also key

1.  List your objectives and rank them by degree of priority:

• Saving for retirement
• Providing for children's education
• Purchasing real estate objects

2.  Risk tolerance will be:

• High for less important objectives
• Low for important objectives

Investment horizon:  the longer, the better!

1.  The longer the investment horizon, the higher the risk ability

• .... as investments may recover from potential losses

2.  The shorter the investment horizon, the lower the risk ability

• .....  as investments cannot recover from potential losses.

3.  Unless you want to speculate ... but at your own risk!

Cognitive biases and the 3 steps in investing

Cognitive biases affect investment decisions when:

1.  Defining the investment universe

• Choosing which asset classes / securities are taken into consideration

2.  Constructing the optimal investment strategy

• Forecasting expecting returns and risk

3.  Adjusting and rebalancing the portfolio.

Cognitive biases:  defining the investment universe

When defining the assets universe you want to invest in:

• You tend to over-invest in local companies (home bias)
• You tend to overweight recent information (recency bias)

You should get out of your comfort zone and do extensive research on securities which may not necessarily be close to your home, nor provide readily available information.

Cognitive biases:  constructing the portfolio

When making forecasts:

• You may be influenced by recent data, which may not be relevant (anchoring bias)
• You tend to be over-confident (overestimating expected returns and / or underestimating risk)
• You tend to look for evidence which will confirm our beliefs and ignore information that contradicts them (confirmation bias)

Look for the black swan!

Cognitive biases:  rebalancing

When rebalancing the portfolio:

• You tend to overestimate the value of assets you own and underestimate the value of (similar) assets you do not own (endowment effect)
• You tend to sell winning positions too soon and hold onto losing positions for too long (disposition effect)

The right question to ask yourself

For example:  

You bought 1000 Nokia shares at 30 EUR.  The stock goes to 60 .. and then drops to 20 EUR.  The question to ask yourself is:

"If I had 20,000 EUR today, would I purchase 1000 Nokia shares?"

• If you answer "yes", then keep the position.
• If you answer "no", then sell it.

Conclusions

Before constructing a portfolio, you need to define your

• Objectives
• Risk ability and tolerance

You should be aware that you are influenced by cognitive biases which may lead to sub-optimal investment decisions.

You should try to adjust as much as possible for these biases.

Investment Constraints

Liquidity

Liquidity refers to the ability to readily convert investments into cash at a price close to fair market value.

Investors may require ready cash to meet unexpected needs and could be forced to sell their assets at unfavourable terms if the investment plan does not consider their liquidity needs.

Time Horizon

Time horizon refers to the time period between putting funds into an investment and requiring them for use.  

A close relationship exists between an investor's time horizon, liquidity needs and ability to take risk.
The shorter the time horizon the harder it would be for an investor to overcome losses.

Tax Concerns

Tax concerns play a very important role in investment planning because, unlike tax-exempt investors, taxable investors are really only concerned with after-tax returns on their portfolios.

Legal and Regulatory Factors

Investors also need to be aware of legal and regulatory factors.

For example, some countries impose a limit on the proportion of equity securities in a pension fund's portfolio.

Unique Circumstances

There may be a number of individual and unusual considerations that affect investors.

For example, many investors may want to exclude certain investments from their portfolios based on personal or socially conscious reasons.

Here’s what Warren Buffett said how he got so rich

Here’s what Warren Buffett said when Tony Robbins asked him how he got so rich

NOV. 16, 2015, 1:30 AM

Billionaire Warren Buffett hasn’t always been as incredibly rich as he is today — in fact, 99% of his wealth was earned after his 50th birthday. Everyone has to start somewhere, even the wealthiest, most successful people.

The investing legend has been slowly building his fortune over the years, and today, the 85-year-old billionaire is one of the richest men in the world, with an estimated net worth of over $60 billion.

How did he come to earn such a mind-blowing amount of money?

Motivational speaker and author of “MONEY: Master The Game,” Tony Robbins, decided to ask him.

“I asked Warren Buffett — I said, ‘What made you the wealthiest man in the world?’” he tells entrepreneur and business coach Lewis Howes in an episode of his podcast,”The School of Greatness.”

“And he smiled at me and said, ‘Three things: Living in America for the great opportunities, having good genes so I lived a long time, and compound interest.”

Buffett has always been an advocate of keeping things simple and focusing on the long-term — that’s why he recommends low-cost index funds. 

One of the keys to Buffett’s wealth is simply time — 60 plus years of smart investing has allowed him to reap the benefits of compound interest.

Compound interest is when the interest earned on your investments earns interest itself — it’s what causes wealth to rapidly snowball, and in Buffett’s case, snowball to billions and billions of dollars.

Read more at http://www.businessinsider.my/how-warren-buffett-got-rich-2015-11/#S8a8PGvZDpxjKKZC.99

Don’t Let Your Losers Become Big Losers

Don’t Let Your Losers Become Big Losers

So with my Trailing Stop Strategy, when would I have gotten out of the failing muscle-shirt business? You already know the answer.

Remember, the shares started at $10 and fell immediately. Instead of waiting around until they fell to $6 as the business faltered, using my 25% Trailing Stop, I would have sold out at $7.50. And think of it this way – if the shares fall to $8, you’re only asking for a 25% gain to get back to where they started. But if the shares fell to $5, you’re asking for a dog of a stock to rise 100%. This only happens once in a blue moon – not good odds!

Take a look at how hard it is to get back to break even after a big loss...

You’ll Never Recover
Percent fall in share price	Percent gain required to get you back to even
10%	11%
20%	25%
25%	33%
50%	100%
75%	300%
90%	900%

So what’s so magical about the 25% number? Nothing in particular – it’s the discipline that matters. Many professional traders actually use much tighter stops.

Ultimately, the point is that you never want to be in the position where a stock has fallen by 50% or more. This means that stock has to rise by 100% or more just to get you back to where it was when you bought it. By using this Trailing Stop Strategy, chances are you’ll never be in this position again.

http://www.dailywealth.com/1041/Don-t-Lose-Money-The-Most-Important-Law-of-Lasting-Wealth

Redefining Investor Risk

by Troy Adkins 

You have probably been told by many financial advisors that your risk tolerance should be a function of your investment time horizon. This belief is touted by almost everyone in the financial services industry, because it is predominately accepted that if you plan to invest for a long period of time, you can make more risky investments. However, before blindly accepting this theory as factual truth, let's look at four ways in which risk can be defined. After thinking about risk from these four different perspectives, you may reach a different conclusion about investing. (Forget the clichés and uncover how much volatility you can really stand. To learn more, see Personalizing Risk Tolerance.)

Risk Theory No.1: Risk is Reduced if You Have More Time to Recoup Your Losses
Some people believe that if you have a long time horizon, you can take on more risk, because if something goes wrong with your investment, you will have time to recoup your losses. When risk is looked at in this manner, risk does indeed decrease as the time horizon increases. However, if you accept this definition of risk, it is recommended that you keep track of the loss on your investment, as well as the opportunity cost that you gave up by not investing in a risk free security. This is important because you need to know not only how long it will take you to recoup the loss on your investment, but also how long it will take you to recoup the loss associated with not investing in a product that can generate a guaranteed rate of return, such as a government bond.

Risk Theory No.2: A Longer Time Horizon Decreases Risk by Reducing the Standard Deviation of the Investment
You may have also heard that risk decreases as the time horizon increases, because the standard deviation of an investment's compounded average annual return decreases as the time horizon increases, due to mean reversions. This definition of risk is based on two important statistical theories. The first theory is known as the law of large numbers, which states that the likelihood of an investor's actual average return achieving its long run historical average return increases as the time horizon increases – basically, the larger the sample size, the more likely the average results are to occur. The second theory is the central limit theorem of probability theory, which states that as the sample size increases, which in this context means as the time horizon increases, the sampling distribution of sample means approaches that of a normal distribution.

You may have to ponder theses concepts for a period of time before you comprehend their implications about investing. However, the law of large numbers simply implies that the dispersion of returns around an investment's expected return will decrease as the time horizon increases. If this concept is true, then risk must also decrease as the time horizon increases, because in this case, dispersion, measured by variation around the mean, is the measure of risk. Moving one step further, the practical implications of the central limit theorem of probability theory stipulates that if an investment has a standard deviation of 20% for the one-year period, its volatility would be reduced to its expected value as time increases. As you can see from these examples, when the law of large numbers and the central limit theorem of probability theory are taken into account, risk, as measured by standard deviation, does indeed appear to decrease as the time horizon is lengthened.

Unfortunately, the application of these theories is not directly applicable in the investment world, because the law of large number requires too many years of investing before the theory would have any real world implications. Moreover, the central limit theorem of probability theory does not apply in this context because empirical evidence shows that a constant standard deviation is an inaccurate measure of investment risk, due to the fact that investment performance, is typically skewed and exhibits kurtosis. This in turn means that investment performance is not normally distributed, which in turn nullifies the central limit theorem of probability theory. In addition, investment performance is typically subject to heteroskedasticity, which in turn greatly hinders the usefulness of using standard deviation as a measure risk. Given these problems, one should not postulate that risk is reduced by time, at least not based on the premise of these two theories. (For more information on how statistics can help you invest, check out Stock Market Risk: Wagging The Tails.)

An additional problem occurs when investment risk is measured using standard deviation, as it is based on the position that you will make a one-time investment and hold that exact investment over the length of the time horizon. Given that most investors employ dollar-cost averaging strategies that entail ongoing periodic investment contributions, the theories do not apply. This is because every time a new investment contribution is made, that portion is subject to another standard deviation than the rest of that investment. In addition, most investors tend to use investment products such as mutual funds, and these types of products constantly change their underlying securities over time. As a result, the underlying concepts associated with these theories do not apply when investing.

Risk Theory No.3: Risk Increases as the Time Horizon Increases
If you define risk as the probability of having an ending value that is close to what you expect to have at a certain point in time, then risk actually does increase as the time horizon increases. This phenomenon is attributed to the fact that the magnitude of potential losses increases as the time horizon increases, and this relationship is properly captured when measuring risk by using continuously compounded total returns. Since most investors are concerned about the probability of having a certain amount of money at a certain period of time, given a specific portfolio allocation, it seems logical to measure risk in this manner.

Based on Monte Carlo simulation observational analysis, a greater dispersion in potential portfolio outcomes manifests itself as both the probability up and down movements built into the simulation increase, and as the time horizon lengthens. Monte Carlo simulation will generate this outcome because financial market returns are uncertain, and therefore the range of returns on either side of the median projected return can be magnified due to compounding multi year effects. Furthermore, a number of good years can quickly be wiped out by a bad year.

Risk Theory No.4: The Relationship Between Risk and Time from the Standpoint of Common Sense
Moving away from academic theory, common sense would suggest that the risk of any investment increases as the length of the time horizon increases simply because future events are hard to forecast. To prove this point, you can look at the list of companies that made up the Dow Jones Industrial Average back when it was formed in 1896. What you will find is that only one company that was part of the index in 1896 is still a component of the index today. That company is General Electric. The other companies have been bought out, broken up by the government, removed by the Dow Jones Index Committee or have gone out of business.

More current examples that support this empirical position are the recent demise of Lehman Brothers and Bear Sterns. Both of these companies were well established Wall Street banks, yet their operational and business risks ultimately led them into bankruptcy. Given these examples, one should surmise that time does not reduce the unsystematic risk associated with investing. (This company survived many financial crises in its long history. Find out what finally drove it to bankruptcy. Read Case Study: The Collapse of Lehman Brothers.)

Moving away from a historical view of the relationship between risk and time to a view that may help you understand the true relationship between risk and time, ask yourself two simple questions: First, "How much do you think an ounce of gold will cost at the end of this year?" Second, "How much do you think an ounce of gold will cost 30 years from now?" It should be obvious that there is much more risk in trying to accurately estimate how much gold will cost in the distant future, because there are a multitude of potential factors that may have a compounded impact on the price of gold over time.

Conclusion
Empirical examples such as these make a strong case that time does not reduce risk. Given this position, investors should reach a very important conclusion when looking at the relationship between risk and time from the standpoint of investing. You cannot reduce your risk by lengthening your time horizon. Therefore, the only way you can mitigate the impact of unsystematic risk, is by developing a broadly diversified portfolio.

by Troy Adkins (Contact Author | Biography)

Mr. Adkins is a senior investment analyst with a global tactical asset management firm. He works and resides in New York City. He has a diverse background and more than 10 years of investment experience.

Filed Under: Investing Basics, Investment

http://www.investopedia.com/articles/trading/10/investors-need-to-know-risk-time.asp

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Understanding Risk And Time Horizon

The interaction between your risks and your time horizon influ...

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The interaction between your risks and your time horizon influences every investment decision you make, whether you know it or not. Learn the basics here. Read: Redefining Investor Risk