Risk and your Time Horizon
So far we've been seeing that the stock market is unpredictably risky in the short run.
The good news is that long-term investors get much smoother sailing.
Look what happens to volatility as your time horizon grows from one year, to ten, to fifteen or twenty:
Risk clearly shrinks as your time horizon grows, whether you measure risk by standard deviation or by the painfulness of the actual bad outcomes.
If you're a portfolio-churning short term investor, hurting yourself in the market is as easy as falling off a high and slippery log;
but with a longer time frame, even the worst outcomes are usually better than inflation.
Above-Average Risk
Strictly speaking, this calculator doesn't show that risk decreases with time;
it shows that that's what has happened in the past, on average.
But there's more to risk than historical averages.
For example, if you buy at a time when P/E ratios are at historic highs, you should expect your returns to be below average.
Here's another example of non-random risk.
Set the time horizon for ten years, adjust for inflation, and notice how the pain is concentrated around the inflation of World War I and (worse) the "stagflation" of the 1970s.
There's a lesson here: you don't want the government to deal with deficits by devaluing the dollar.
(This would be a good time to read Free to Choose again.)
Note About Averages
Don't be concerned that the "average" tends to shrink with time in the calculator;
it's just approaching the long term
annualized return rate
(plus or minus some error, since the number of data points isn't constant).
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