Time equals less (and more) risk
By Gary Silverman, CFP®
Last week we learned that there are three truths about investment risk you need to remember: First is that risk exists in some form in every investment; second, investors seeking greater investment rewards must be willing to accept greater risk; and third, the risks an investor faces can vary depending on how long an investor has to achieve her or his investment goals.
There are some interesting ramifications that come from that third point. Most investment professionals will tell you that time will reduce risk. But quite a few economics professors will tell you that the more time you spend investing, the worse your risk becomes.
Which of them is right?
The stock market has a 20% drop on average once every 5 years. That’s a risk. Sometimes there is a 1 year gap between drops. Sometimes there is a 13 year gap between drops. But on average it happens every five years.
So, if you put your money in the market next January 1 and pull it out 12 months later on December 31, you have a 1 in 5 chance that you will experience one of those 20%+ declines. If, on the other hand, you put your money in and leave it there for 20 years, it’s all but guaranteed you will go through at least one and more likely several of those falling moments. That’s what the professor is talking about, the longer you are in, the more likely you’ll experience a nasty event.
But the investment professional is correct as well. That’s because if you put your money in the market for one year, you have a 1 in 5 chance of being in one of those 20% drops and not having time to recover from it. You might endure a lesser drop, but enough of one that you’re still at a loss by the end of the year. In fact, over the last 100 years, you would have had about a 1 in 3 chance of ending the year with less money than you started with.
If, on the other hand, you put your money in and left it there for 20 years, there has not been a time in the last 100 years that you would have lost money.
So even though the professor is correct and you will lose money sometime during your investment time horizon, that’s not what you should be concerned about. Rather it is the risk of whether you will lose money from when you start saving for your goal up until the moment you spend it that you need to be concerned about.
While risk cannot be eliminated, it can be managed through careful planning and following a disciplined investment process. Next week we’ll examine the types of risk that are out there and what to do about them.
This article was published in the Wichita Falls Times Record News on January 8, 2017.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing.