Investment Risk and the Growth of Wealth: The Importance of Course Corrections

I have a problem. In fact, I think we all have a problem:

We have been way too focused on returns, resulting in the utter destruction of our wealth.

The investment industry has been built using tools that might be appropriate for understanding investments, but are totally worthless for investors. In real life, real people, using real money do not care about returns. We care about our wealth, and the two are not the same. They are not the same!

Risk and investment returns
Nowhere is this paradox more evident than the core tenet that risk goes down over time. When talking about investing, everyone says that risk goes down over time. Every investment book, every investment advisor, and for sure any class you took in college, all shout this idea from the rooftops, an idea illustrated in the chart below.

 

It's time to back up and understand what this chart is really telling us.

It measures the best and worst periods in terms of annualized returns from 1926 through March 2009 for the S&P 500, with the average return for the entire period in grey.

For example, while that average return for the entire period is 11.28%, you had a one year period that was positive 162% or negative 67%, a three year period that ranged from up 43% per year to down to 42% per year and so on. As you measure longer and longer periods, the best and the worst start to narrow around this long-term average of 11%.

Just to make sure we are clear before we move on:

  • This is a chart of the range between best and worst annualized rates of return for different periods of time.
  • It clearly shows that the range of potential outcomes (in % terms) narrows over time.

Somewhere along the line, someone locked in a back room at a university decided that the range of returns (measured in percentages) was a good proxy for risk. Somehow it is was useful to measure risk in terms of how much something goes up and down in percentage terms.

This is where things get sticky.

Risk and the growth of wealth
It might be true that “risk” goes down over time, if you define risk this way. If you are an investment, this would be a good way to measure risk. But you are not an investment — you are an investor. Real people do not care about their return. We care about our money. We don't eat percentage pie. You can't pay your kids' tuition with percentages; you pay with dollars. Everyone I have ever met thinks of risk as the possibility that they will run out of money.

So the question is not about the accuracy of this chart, but about the conclusion that we draw from it. When you are a real person, measuring risk in terms of returns is like trying to measure temperature with a ruler. Fine tool — wrong application!

Investors measure risk in terms of dollars; investments measure risk in terms of percentages.

When we measure risk in terms of wealth, risk goes way up over time!

The chart looks like this:

 

This chart shows what happens to a dollar if we invested during those best and worst time periods from chart one. Depending on the sheer luck of timing, $1 could have ended up growing to $62.52 — or just $9.51 thirty years later. That is a huge range of potential outcomes. If you add in withdrawals, things get even more “risky”.

This should make sense. It's basic math, compounding over time. When you leave on a trip from Los Angeles to Miami, if you are two inches off course, you most likely would not even notice when you are over Nevada, but without any course correction you will end up in Maine! Maine is not a bad place — unless you planned to be in Florida.

The issue is that most of us are on auto-pilot, thinking that if we just “set the course and forget it” that our risk will go down over time.

That is simply not that case.

So what?
I'm still working through all the implications of this, but they at least include the following:

    1. The timing of major financial decisions has huge impact on our success. If you happened to retire with a lump sum at the beginning of one of the best 30-year periods, your experience would be dramatically better than if you retired just before one of the worst. The problem is that we really don't know which one we are in until after the fact.

 

    1. Average is not normal. If you set a course based on some version of a long-term average return, then you are likely to end up somewhere else. Most of the time, the surprise destination appears to be good, but sometimes it's bad. In fact, it's bad often enough to make me question some of my long-held beliefs.

 

    1. Making course corrections is at least as important as setting the course!

 

    1. Rates of return are only one factor in meeting your long-term goals. There are other levers to pull when we need to adjust, other levers that we have much more control over, including retirement date, savings goals, withdrawals, etc.

 

  1. We really can't rely on the idea that if you buy and hold, your risk goes down. While that may still be the best approach to investing, in terms of meeting your financial goals, there are a lot of other things that you need to think about as you go forward.

The point of this article is really just to raise awareness. I have been thinking about this for a long time. I have been in the financial-planning industry for over 10 years. I really can't think of one concept that is more important to understand right now. Here's a video that summarizes my thoughts on this subject:

 

I want to leave this open-ended. This is the beginning of a discussion, not the end. However, it's important to understand that the process of planning for your future remains the same:

  1. Determine where you are today.
  2. Define the destination.
  3. Chart a course to get there.

But now that you know your risk of not getting there is actually growing over time, make sure you take the time to do regular course corrections. Are you on course to meet your goals? Have you made corrections in the past — or do you expect to do so in the future? How do you feel about the relationship between wealth and risk?

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ObliviousInvestor
ObliviousInvestor
11 years ago

“We don’t eat percentage pie.” Indeed!

I created a ppt video about this concept a few months back–showing that the possible range of ending values widens as time horizon increases. Somebody even commented to “correct” me, mentioning that returns become more predictable as time goes by. Apparently it’s quite drilled into our heads.

While I’m obviously not a fan of checking one’s portfolio too frequently, this (along with rebalancing) is a reason why we need to do it at least periodically.

Russ
Russ
11 years ago

I’m a bit confused by this post. Whilst the recommendations it makes are good ones, it’s not like people don’t already know this. It seems odd to shout from the rooftops about the dangers of ‘autopilot’ as if it’s some newly-discovered threat, when every PF blog and book is hoarse from repeating the mantras of asset allocation, regular rebalancing, and dollar-cost averaging. Is it not true that those three concepts address all 5 of this post’s conclusions?

Scott Moonen
Scott Moonen
11 years ago

I think the key to this is not so much course correction as it is dollar cost averaging. Most of us don’t approach investment only with a single lump sum. Instead, we have some savings to begin with (this is the part that might have earned as little as $9.51), and some monthly and yearly amounts that we are able to budget and add to our savings. By virtue of dollar cost averaging, these monthly and yearly amounts will often do much better for us than the dollar that only made $9.51. I think this is a much stronger answer… Read more »

d^2
d^2
11 years ago

i think the average is misleading, because it is assuming something about the distribution of 30-year trajectories. i don’t know how the average here was calculated, but i assume it summed all N 30 year returns and divided by N. this implicitly assumes that all N trajectories are equally probable.

i’d guess that is unlikely. if you happened to end your 30 year run at the height of the stock bubble in 2000, you cashed out with a big chunk of money. but that is very unlikely to happen, so it shouldn’t be influencing your average upwards.

Frugal Bachelor
Frugal Bachelor
11 years ago

Good morning, JD. This is a topic which I’m interested in, I’m glad you’re starting to cover investment topics, and I made my attempt to work through the article. However it is very disorganized, and very confusing, difficult to follow, too technical, and boring. The gap in quality in between the guest posters and your own posts is stunning. Maybe you could rewrite this post in your own words and tone, and repost it, so the rest of us can follow it and enjoy. I don’t think most people who visit your blog come because of the depth information presented,… Read more »

a conscience life
a conscience life
11 years ago

This is an interesting post. However, I am not sure that I agree with your definition of ‘risk.’ I have two major objections, actually. 1) Based on the second chart, it seems that you define risk as “not obtaining the maximum increase in value” or perhaps “not obtaining the projected average increase in value”? I think many people define risk as “losing money” and in this context, risk *does* decrease with time invested. You can see in your second figure that the worst case scenario results in negative values initially, but eventually gives positive final values (ie. no loss in… Read more »

ObliviousInvestor
ObliviousInvestor
11 years ago

For what it’s worth, I quite appreciate a more technical post (guest or otherwise) from time to time. And I wouldn’t exactly call this article “very confusing.”

Michael
Michael
11 years ago

I think the 11% average is skewed as well. While the average return might be 11%, it does not quite translate to dollars. Example: I have 100 dollars First Year: + 20% Second Year: – 15% Third Year: + 10% Fourth Year: – 20% Fifth Year: + 15% Average Percent Return = (20 – 15 + 10 – 20 + 15)/5 = 2% Average return Now lets put the original 100 dollars in play and see what we end up with First year (100*1.2) = $120 Second Year (120*.85) = $102 Third Year (102*1.1) = $112.2 Fourth Year (112.2*.8) =… Read more »

Wise Money Matters
Wise Money Matters
11 years ago

I think this is mostly just common sense. But it also forgets about something: goals change. Sure, some long-term goals stay the same but those are usually universal. For instance, we all want to be able retire some day. While the details differ slightly from person to person it basically means we need to save for retirement. Now other goals change widely. Someone may have gone to school to become a teacher and then decide they hate kids. Or someone might have a baby and decide to quit their career to be a stay at home parent. While course corrections… Read more »

Ryan
Ryan
11 years ago

I’m no expert, but I think you’re wrong. Yes, over the long term we see a greater spread between the best and worst possible outcomes. But even the worst possible scenario ends up giving them 9.51:1 (not a great rate of return). But consider the worst possible rate of return over one year -67%. It’s the opposite side of the coin of whether to invest in one company or 40. You are hedging your bets in both instances–in effect reducing your risk by playing the odds. Or to look at it another way, consider the thought experiment of the gambler’s… Read more »

ABCs of Investing
ABCs of Investing
11 years ago

Interesting post. I know from my experience that someone just starting out in investing doesn’t have much risk because they don’t have much invested. You are far better off having a bad year (-40%) if you young because that 40% might only be $4k or $40k. Later on that 40% might be $400k if you are 100% equities. I think asset allocation has to be part of the discussion as well – I’m not a believer in being too conservative but if you get a point in life where you have a lot of money invested and a big loss… Read more »

ABCs of Investing
ABCs of Investing
11 years ago

One other thing to add – the idea that the risk goes down over long periods of time is true. But for equities – that “lower risk” area is always in the future. Someone who starts investing in equities when they are 25 might have a 40 year time horizon until retirement. Any money that they invest when they are 25 has a reasonable chance of getting a decent return over the next 40 years. But what about when that person is 55? At that point it’s only 10 years to retirement and who knows what the 10 year return… Read more »

Chad
Chad
11 years ago

I found the article interesting since it delved into a topic not generally covered in this blog. I do think that the author is a little too alarmist about his conclusions, which have issues that other posters already pointed out. I do agree with a major underlying point that Carl has however, the average return of the stock market (or bonds or whatever) will probably NOT be achieved by any of us and thus shouldn’t be the main factor in our decision-making. The reasons are many: past performance does not guarantee future results, dollar cost averaging, time of entrance in… Read more »

CB
CB
11 years ago

It seems to me that several of the commenters are still thinking in terms of investment risk when what the article is getting at is that there are two different but equally important types of risk, investment risk and financal plan risk. It is true that the rate of return will likely start to approach the average after X years. But in order to reach your goals, as you get closer to the end of your timeframe, you can’t have a bad year or bad 10 years. If you do it’s much harder to reach your goals. Say your one… Read more »

Dylan
Dylan
11 years ago

Carl, This is one of the clearest, most direct explanations of what the myth/fallacy of time diversification. Great job! But, it’s your same point that many investment advisers actually have been trying to shout from the rooftops. I even detect some of the louder ones’ influence in your post, like Dave Loeper. For those that don’t see the risk that Carl is referring to, I don’t think the point is that it’s still a positive return or that it’s not the maximum. The risk is the very real chance of not having enough of the dollars you’ll need in the… Read more »

Carl Richards
Carl Richards
11 years ago

A few points of clarification: [1] RISK is not the range of one year returns. IT IS the possibility that you will not have enough money to meet your goals. [2] Making course corrections to your financial plan is not the that same thing as asset allocation & rebalancing. THAT WILL NOT SOLVE the problem you have if your equity investments earn 2% per year for 20 years when you had planned on them earning close to the long term average of 11%. At that point your plan will be grossly underfunded and you WILL have to make some painful… Read more »

Chett
Chett
11 years ago

There are some comments that suggest that the guest poster is at fault for presenting an old topic in a new way. Isn’t that what most of the information found in PF blogs, articles and news does? While I appreciate constructive and appropriate criticism of information, (I think that is why the information here is generally so good, people who share here know they are subject to scrutiny) I think some people only take in information as critics, not as someone truly willing to learn from others. If people are checking in each day waiting to see something completely new… Read more »

David D
David D
11 years ago

An excellent, thought provoking article Carl.

This helps to show that we are the biggest investment mistake in our wealth equation.

Ouida Vincent
Ouida Vincent
11 years ago

I have written extensively about this on my blog using calculators at moneychimp.com In November of 2008 Warren Buffett wrote that he was “buying American” stocks. The impressive thing was not that he was buying stocks, but the more subtle aspect of the article, Warren Buffett’s time horizon is infinite! The only way that risk diminishes over time vis a vis stocks is through an infinite time horizon. Because individual investors ALWAYS have a time horizon, market timing remains an aspect of investing and risk, therefore cannot diminish over time.

Paul in cAshburn
Paul in cAshburn
11 years ago

@Chett @17. I agree with you. If I hear info again, since I – and my thoughts and my situation – change, the info may strike me a different (and perhaps for the first time, useful) way. Repeated – if well articulated – info welcome here. 🙂 You can think of risk so many ways. You may set off on foot for a restaurant you can see several blocks away (retirement), but if there’s a hole in your pocket (inflation) or someone robs you (Madoff) you may not be able to pay the menu prices. But if you put some… Read more »

Brian
Brian
11 years ago

While Carl does have some argument to stand on, He’s very preachy and seems to miss the point. He throws the baby out with the bathwater when inventing his own definition of risk. He’s very quick to toss out decades of study when it dosen’t align with his current argument.

Risk *is* variability of returns. What Carl is talking about is how to choose how much risk to take on.

Dylan
Dylan
11 years ago

@Brian,

He’s not redefining risk, nor is this his invention, nor is he tossing out decades of research.

He’s suggesting that it may be more appropriate to consider a different definition of risk.

Risk is the very real chance that thinks won’t go the way you intended. That could be volatility. It could also be bad timing.

It’s not about “how much” risk to take on, it’s about knowing what you are risking.

Carl Richards
Carl Richards
11 years ago

@Brian: Thanks for the feedback. It is all very valuable. This is not MY definition of risk, nor am I talking about “how much risk to take on”. What I am saying that measuring FINANCIAL PLANNING risk using the tool that was designed for measuring INVESTMENT RISK is like measuring temperature with a ruler. It just doesn’t work. Try telling a 60 year that was hoping to retire this year that risk goes down over time. They have been saving for 35 years and just happen, out of pure luck (bad), to have the last decade of below average returns… Read more »

Russ
Russ
11 years ago

@Carl You seem to be getting pretty defensive, without correcting the flaws that have been pointed out. Your example of a 60-year-old retiring this year most certainly is addressed with asset-allocation – someone on the verge of retirement should be mostly in bonds rather than equities, and would therefore be relatively unaffected by below average returns. And ranting about “the problem you have if your equity investments earn 2% per year for 20 years when you had planned on them earning close to the long term average of 11%” is based on a false premise. Unless you have a time… Read more »

Elizabeth
Elizabeth
11 years ago

Carl – I am no investment expert (believe me, I’m barely a beginner), but isn’t it true that a 60-year-old should probably be holding more stable assets if they are planning on retiring soon? I was under the impression that the closer you get to retirement, the less money you would have invested in the market. This is what most experts recommend, if I am not mistaken. If this were true and a 60-year-old investor had their assets tied up in bonds and CDs, etc., then their retirement may only be mildly affected by the current economy. I don’t know… Read more »

Paul in cAshburn
Paul in cAshburn
11 years ago

Wouldn’t the absolute worst case be someone who was excessively into stocks up to 2008, and now is excessively into long-term bonds just in time to get creamed by rising interest rates (if you have to sell a bond, capital losses) and inflation (value of interest payments worth less in future)? First, you lose 30-50% in stocks, then much the same happens to you in bonds. To avoid this, you have to accept low interest on shorter term bonds now. So now we have to save not twice as much, but four times as much because short term interest rates… Read more »

Dylan
Dylan
11 years ago

I’m watching the back an forth between Carl and some of the commenters, and it is not unlike one person saying, “that sports car is red,” and then the response is, “no, that car is fast.” The points about using asset allocation are fine points, but even if you are 50%/50% stocks and bonds, 25%/75%, or any other allocation, the range of potential outcomes increases with time. Adding less volatile asset classes may slow the widening of the range, but there is still an increasing risk as time passes that ought to be monitored. So the car can be both,… Read more »

Ryan
Ryan
11 years ago

@Russ: We’re on the same page. @Dylan: 60 miles down the road, the bridge may be out, but you can’t know that until you get there and taking another route when this route is shortest is foolish. That bridge being out is unlucky, but that doesn’t mean your strategy is wrong. Similarly, the 60 year old who has gotten a 2%ROR over the last 20 years has gotten a crap string of hands, but that doesn’t mean he’s played the game wrong. And of course this is why orthodox financial planners will transition a person’s assets into bonds as they… Read more »

Russ
Russ
11 years ago

@Dylan I was specifically addressing the part of the metaphor that said “there is a lot I can do with the next hour”. I dispute that. If I look at my investments and figure I’m not hitting my 8% a year target, what can I do in ‘the next hour’? Switch to bonds? Cash? Gold? (Alright, that last one’s a joke.) None of these work, because I have no idea how any of those assets are going to perform *either*. In actual fact, since I can’t *know* that the bridge is out, my best course of action would be to… Read more »

ObliviousInvestor
ObliviousInvestor
11 years ago

Dylan, I think you summed it up pretty well there. It appears to be two entirely separate conversations. Carl’s post did not argue against intelligent asset allocation, diversification, or rebalancing. The point of the post is simply that when we say that “stock returns become more predictable over time,” it’s a bit misleading because we’re only looking at percentage returns. When we look at total return as measured in dollars, the range of possible values increases over time. As far as I can tell, all Carl was saying was that we need to recognize that fact and plan accordingly. Seems… Read more »

StackingCash
StackingCash
11 years ago

The stock market is a Ponzi scheme. The CEO’s are at the top and investors are at the bottom. Sorry to be so cynical but sometimes it’s necessary.

John Buerger
John Buerger
11 years ago

Carl – This is your best summary of this information to date. Keep working through this paradigm because it is important. Risk is officially defined as “deviation from an expected result.” Somehow the general understanding of this has morphed into the garbage that people now hold dearly as gospel truth. Average is NOT normal – so why do studies insist on focusing on average returns. While I don’t believe in Monte Carlos (mostly because they use bell-shaped return assumptions rather than fat-tails), a Monte Carlo clearly shows that risk (deviation from expected results) increases over time. A fat-tail model would… Read more »

BP
BP
11 years ago

Ditto to @ObliviousInvestor @Russ – I think you have a better understanding of how investment risk can alter the timing and achievement of your goals than most. I think that is Carl’s point. A lot of people don’t see the need to either alter their goals or alter their investment style to fit those new goals. I take it that in the course of diversifying, evolving your asset allocation, and rebalancing, you are doing so with respect to your goals and objectives. I don’t think that Carl’s article is a knock against any of those principles, just a reminder that… Read more »

Carl Richards
Carl Richards
11 years ago

Great discussion! This issue is really important to understand so having such thoughtful comments and questions is helpful. @Elizabeth [25] Thanks for the question. Most financial planners would agree that the as you get older [or closer to a goal] that you will reduce your exposure to equities, BUT you will still have something in equities the swings will still effect you. Which means that you need to be paying attention and making course corrections [save more, spend less, retire later, etc]. The sooner you are aware that you are off course and headed for a cliff the more effective… Read more »

CB
CB
11 years ago

Dylan & Obilvious are right about the point Carl is trying to get across. Russ et al are correct as well that the three basic pillars help mitigate the risk of rate of return being below average.
Maybe metaphors should come with a key, a legend just like we used to put on the maps and graphs we made in elementary school.

Dylan
Dylan
11 years ago

@Russ and Ryan, I think the disconnect here is that the target is not meant to be a rate of return (another investment measure, not an investor measure. The correct measure should be a probability of a least meeting a future cash flow need. Let’s look at the guy with the crappy returns and say he want’s to retire a 60 and spend $50,000 per year before inflation. He’s 40 now, and as each year of crappy returns occur, he gets further from that goal (the bridge is going out). We can measure this, because at age 45 (for example)… Read more »

Russ Thornton
Russ Thornton
11 years ago

Wow, some of the comments make me wonder if I’m reading the same post that you are 🙂

I would like to let some more comments trickle in before sharing my thoughts, but bottom line is that I think Carl raises an important point and does a good job of explaining why it’s important.

Also, if you’d like to hear Carl talk about this issue further in a conversation with Bill Schuletheis, check out their most recent episode of BehaviorGap Radio:

http://www.behaviorgapradio.com/

aconsciencelife
aconsciencelife
11 years ago

@ObliviousInvestor “the range of possible values increases over time” I agree that this is true, however, it does ignore the fact that the probablity of getting a total return close to the projected average *increases* with time. Think of flipping a coin. Each time you flip it, there is a 50% chance of heads and a 50% chance of tails. If I flip the coin once, then there is a narrow distribution of possible outcomes, either 1 head or 1 tail. If I flip the coin twice, then the possible outcomes have widened, now it is either 2 heads, 2… Read more »

Sceptic
Sceptic
11 years ago

So, it seems general opinion is that Person A needs to sit on some chunk of risky (good-risky, not bad-risky) stock to get their happy % they need to retire. BUT if they hit their retirement date still holding too large a % of this risky stock at the same time the curve is way down then they are screwed. Hmm. So Person A needs to try to avoid this so they put less in the risky stock 5 years before they retire, but now their happy % isn’t quite so happy so they need to work another year or… Read more »

Dave Shafer
Dave Shafer
11 years ago

Wow, excellent post Carl. Several folks seem to really get what you are talking about. Put simply, a real financial plan starts with where you are today, establishes an endpoint [$50K/year for 25 years for example] and then fills in the process of getting there. If you find that you need to get a better return in order to get to your goal then you need to adjust your investments. Or maybe you need to save/invest more [assuming that is possible]. Bottom line, is that is what a financial plan is all about, making changes as the reality of your… Read more »

Monevator
Monevator
11 years ago

Carl’s always worth reading and the graph juxtaposition is cute, but as others have said this post isn’t actually very relevant in the way it claims to be to real-life investing. In reality, as a private investor you’d be successively investing into different 30 year periods. (Or more precisely one 30 year period, one 29 year period, one 28 year period, etc, assuming you were aiming for a retirement date and the total conversion of your investments after 30 years into some form of fixed income). Dollars invested in one year might be going into a good 30-year period, and… Read more »

Dylan
Dylan
11 years ago

Monevator said: “Perhaps Carl’s issue is more commonly encountered by finance professionals – I believe he is one – who are faced from time to time with investing big lump sums from individuals who have suddenly come into wealth or decided to do something with that bulge under the mattress. But for most of us, this particular issue isn’t an issue.” For most of us this is an issue. As cash flows are introduced (savings now, withdrawals later), the problem compounds. Time horizon is not the start retirement, even if you invest only in fixed income in retirement. Time horizon… Read more »

Brad
Brad
11 years ago

@ Carl

Nice post. I’ll remind folks your closing advice:

Determine where you are today.
Define the destination.
Chart a course to get there.

The premise of your article actually points to the need for asset allocation and understanding unforseen obsticles along the way. The sports car metaphor was actually the best summary of this back and forth dialogue.

Elizabeth
Elizabeth
11 years ago

@ Carl and Dylan – Thanks for your comments, they make a lot of sense. I am a young investor (and I have little to invest at this point). And I consider the future fairly volatile as to what my rate of return may become over the years (as well as many other variable factors). My basic plan is to save responsibly and diversify my investments. I have no idea what will happen over the next 40 years to influence my goals. I think the point you’re making is extremely valid: whatever your goals and whatever your time line, it’s… Read more »

Lord
Lord
11 years ago

In part this is the result of looking at terminal values. A better approach would be to integrate over both accumulation and discumulation phases which would be both more natural and blur the results over longer periods. The best terminal value likely occurs just before a crash and the worst terminal value likely occurs just before an upswing so once one blurs over this extended period the end result is likely more similar.

Ross Williams
Ross Williams
11 years ago

“stocks, due to their inherently more volatile and risky nature, provide a better long-term return than other asset classes because they HAVE TO” No, they don’t “HAVE TO”. It is only necessary that people believe that they will. What is true, is that the less people believe stocks will return, or the higher they believe the risk is, the less other investments will have to pay to get some of those investment dollars. Ultimately, the reason the stock market goes up over time is the same reason our lives get materially better over time. Companies grow and become more productive… Read more »

Rob Bennett
Rob Bennett
11 years ago

Absolutely fantastic post. My thanks both to the author and to J.D. for hosting it. I have never agreed with the conventional advice that young people don’t need to worry so much about suffering big losses in the stock market. Young people should be scared to death about suffering big losses. Why? Young people have the most to gain from the compounding returns phenomenon. When they suffer losses, compounding appliesin reverse. Young people get absolutely killed by being invested in stocks at times of high valuations. If we thought about investors as humans instead of as numbers, this would be… Read more »

partgypsy
partgypsy
11 years ago

I think this is a very worthwhile article and addressed thoughts I have been having that I haven’t been able to articulate in such a clear fashion. Everyone talks about returns, but what everyone really cares about are dollars (and what equivalent resources one can buy with those dollars). I also agree that while stock returns may revert to an average over 30 years, depending on the timing of those up and down returns two investments with the same “average” return can have dramatically different amounts of money at the 30 year mark. Everyone will have different amounts of reactions… Read more »

Ian
Ian
11 years ago

What a great discussion! @ Carl I’ve been following the discussion and wondering “does it make sense to consider the investment risk (as presented in the first graph) inversely?” I mean by this that we are safe to assume our long run average return is the average in the chart when initially placing our money into the market, but as our time horizon closes we look to the ever widening variance and determine what percentage of exposure to that variance we want to have in our portfolio (given our plan.) I realize this in no way contradicts your prescriptions (correct… Read more »

Eamon
Eamon
11 years ago

@Michael

You should use the geometric not the arithmetic mean when calculating average returns on investments. This site has a good explanation: http://betterexplained.com/articles/how-to-analyze-data-using-the-average/

@aconciselife
I strongly agree that the original post is simply presenting the same data in two different formats. The second graph is derived from the first graph! The only real lesson to learn here is that its better to invest small amounts over time rather than large amounts all at once.

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