Articles on investing and capital management, with a quantitative focus.

#bigpicture - Big picture thoughts

I am not a Tortoise


According to Wikipedia, most tortoise species can live to around 100 years, with some living over 150 years.

The tortoise could therefore enjoy these long term 'real returns', after inflation:

Asset Class Real Return
Stocks 5%
Bonds 2%
Gold 1%

Data sources: stock and bond returns are for over 100 years, from Credit Suisse, and gold is based on my own calculation since 1872 using historical prices and historical inflation.

Investment time horizons are a tricky thing

I am not a tortoise.

Your time horizon may be nothing like the tortoise's. This means that it may be unrealistic to think that you will see the ideal, long term historic returns of asset classes. It may make sense to focus a bit more on shorter timeframe returns.

It's true that in the ideal scenario, an investor may have a 30 to 40 year time horizon. However, I would argue that most people have significantly shorter time horizons in practice.

I have seen countless examples in real life:

I seriously doubt that most people have 30 year investment time horizons where they can leave their investments alone. From what I've seen, people usually need (or want) to tap into investments sooner for many reasons.

So what?

The point to all of this is that the ideal, long term returns may be only theoretical. The volatility in asset classes means that returns are unpredictable when you have a shorter time horizon.

I've heard many advisors say that stocks are the best place to be, because the long term returns are expected to be strong. They also say that gold is not a good investment, because long term returns are poor. I agree, for very long time horizons.

However, I think this standard advice totally misses the point that time horizons are often much shorter in practice.

With shorter time horizons, the above table of Real Returns becomes somewhat irrelevant. Instead, the returns become dominated by volatility and irrational short-term market movements.

My own investment approach makes some tradeoffs with this in mind. By diversifying across several assets, I reduce volatility and get a steadier annual return. The return becomes much more predictable, even over shorter time horizons. As a consequence, I sacrifice very long-term performance somewhat.

Jem Berkes