Does Time Cut the Risk of Owning Stocks?
“No,” Says a Nobel-Winning Economist.
While there is a kernel of truth in the argument that a longer holding period increases your odds of making a profit, like many Wall Street myths, the devil is in the details. Friend Roger Schreiner, founder of Select Advisers, makes a compelling argument that the risk of ruin increases the longer you play the buy-and-hold game.
Investing in the S&P 500 index* for one day carries about a 50% chance of winning or losing. Increasing your holding period to one year increases your odds of making a gain to about 68%. With a ten year holding period, the odds of making money increases to 85%.
One can supposedly increase the odds of winning to 100% by holding stocks for a period of 30 years (source: Ibbotson Associates). But, when you start talking about 30 years, you’re talking about “an investment life-time.” And now you’re talking about another risk – that of not having the self-control or time to complete your mission.
Paul A. Samuelson of MIT, a Nobel Prize winner in economics, states that “the longer you own stock, the greater the risk that you will suffer devastating losses in a crash or a series of crashes.” The risk of significant loss increases with time. Risk does not decrease with time as many in the mutual fund industry claim.
And, does the average investor really have the determination to hold through the really tough periods? Can we really ride out a 50% loss like the one in 1973-74, or accept a quick drop of 33% like to one in 1987? Would we be willing to wait out the 25 years it took to recover from the 89% wipeout of 1929? How long will it take for buy-and-hold investors to break even after the 70% Nasdaq crash?
If history is any guide, now that we have had a couple of decent years in the stock markets, most investors will forget the pain of 2000-2002 losses, begin to think stock market investing is easy and will get burned again in their buy-and-hold strategies. Not only because buy-and-hold may fail again, but also because it makes unrealistic assumptions about our tolerance for pain and loss.
So what’s a growth seeking, risk-adverse investor to do? We recommend active strategies that can move to the safety of cash when market declines appear imminent—strategies that Adapt to Changing Markets®. Buy-and-hold investing may have worked over certain time periods, but embracing that high-risk philosophy assures you that you will eventually encounter unacceptable losses.
* The S&P 500 is an unmanaged index considered representative of the broad stock market. Investors cannot invest directly in this market index.
From the Financial Market Review, November 2005.