Most investors view stocks as the high-risk portion of their portfolios, but some recent research contradicts that thesis.
By Morningstar | 19-02-14 | David Blanchett
David Blanchett, head of retirement research for Morningstar Investment Management, recently conducted in-depth research on the volatility of equity as an asset class.
He shared his views with Christine Benz, Morningstar’s personal finance director, on Morningstar’s U.S. website. Below is a summary of the discussion.
The crux of the research
We looked back on historical returns in 20 different stock markets across the world. We looked at time periods from 1 to 20 years and different levels of risk preference. It’s the most comprehensive empirical study on time diversification–this idea that stocks change in terms of their riskiness over time–of any study done so far.
Observation I: For individuals with a long-time horizon, stocks may be the least-risky asset of all.
People think about stocks as being volatile investments, because they are. What we found was that the longer you hold stocks, the safer they become. People think of cash as being a safer investment for longer time periods; stocks actually were a safer investment for someone investing for maybe 10 or 20 years versus cash or bonds.
So if you’re someone with a very long time horizon, stocks actually may be the least-risky asset of all, even though it’s kind of counterintuitive.
Observation II: Investors with a sufficiently long time horizon and a pretty high short-term risk tolerance could be all equity and generate a better return than a blended portfolio.
This really speaks to the idea that the more time you have to invest, the more aggressive you can be. But an important part of that is how comfortable you are holding that portfolio for a long time horizon.
Back in 2008, if you were going to panic and sell out of stocks, then an aggressive portfolio isn’t for you. But if you’re an investor who really can stomach these ups and downs, this evidence suggests strongly that holding stocks is a great long-term investment philosophy.
Observation III: The behavioral piece is the key.
If you’re someone who thinks you might capitulate at the bottom, then an equity-heavy portfolio won’t make sense for you. Look back to how you reacted in 2008, if you had this long-term plan, and you were OK with the market going down 40% and holding on, that’s a good investor for the long haul for stocks. Someone who panicked and sold out in 2009 would not be a good investor for this kind of aggressive portfolio stance.
Observation IV: People in drawdown mode absolutely need to have some investments set aside that they can use for liquidity purposes.
Throughout someone’s lifecycle, stocks can really work. Even for some investors who are older, in retirement for example, and have a lot of guaranteed pension income. If you take that 20-year plus picture of retirement, equities may seem a bit safer all things considered.