Time horizons: the longer, the better
Based on several well-known studies, the length of time that individual investors hold stocks and mutual funds has shrunk precipitously over the past 50 years. Back then it was common for investors to have five-to-10 year time horizons, but today it is typically less than a year. And the trigger for selling and/or buying is often short-term performance chasing: buying recent hot performing funds or asset classes and running from recent losers.
In the chart below, "Longer Time Horizon = Lower Downside Risk," you can see the power of long holding periods when it comes to minimizing downside risk. The longer you extend your time horizon, the less likely you'll experience a loss over that holding period.
Longer Time Horizon = Lower Downside Risk
Source: Schwab Center for Financial Research with data provided by Standard and Poor's. Every 1-, 3-, 5-, 10-, and 20-year rolling calendar period for the S&P 500 Index was analyzed from 1926 through 2010. The highest and lowest annual total returns for the specified rolling time periods were chosen to depict the volatility of the market. Returns include reinvestment of dividends. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no indication of future results.
Patience and stick-to-it-iveness
Admittedly, the development of a long-term strategic asset allocation plan isn't the hard part—it's sticking to it that often becomes the real challenge. We think that the best way for an aggressive investor to have generated the 10.2% annualized return since 1970 was for that investor to have remained aggressive throughout the period, including during nine down years. That meant rebalancing, typically in favor of underperforming asset classes and away from outperforming asset classes. The same goes for the rebalancing associated with maintaining a conservative allocation.
Adding to underperforming asset classes and trimming outperforming asset classes goes against the emotions of fear and greed that often drive investment decision making. But if we learn from our mistakes, use our brains over our hearts and look to our portfolios as rebalancing guides, we can expect a more successful investing future and maybe even get a free lunch along the way.
1. See Schwab.com/portfoliocheckup for five strategic asset allocation models, including Moderately Conservative and Moderately Aggressive.
2. Data from Morningstar, Inc. The return figures for 1970 through 2010 are average, maximum and minimum annual returns of three hypothetical portfolios, which are rebalanced annually with dividends and interest reinvested. Conservative is 15% large-cap stocks, 5% international stocks, 50% bonds and 30% cash. Moderate is 35% large-cap stocks, 10% small-cap stocks, 15% international stocks, 35% bonds and 5% cash. Aggressive is 50% large-cap stocks, 20% small-cap stocks, 25% international stocks and 5% cash. Indexes are S&P 500 index (large-cap stocks), Russell 2000 Index (small-cap stocks), MSCI EAFE® net of taxes (international stocks), Barclays Capital U.S. Aggregate Index (bonds) and Citigroup 3-Month Treasury Bill Index (cash). CRSP 6-8 was used for small-cap stocks prior to 1979; Ibbotson Intermediate-Term U.S. Government Bond Index was used for bonds prior to 1976; and Ibbotson U.S. 30-Day Treasury Bill Index was used prior to 1978.
Important Disclosures
Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.
The S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity, and industry group representation.
Russell indices are market-capitalization weighted and subsets of the Russell 3000® Index, which contains the largest 3,000 companies incorporated in the United States and represents approximately 98% of the investable U.S. equity market. The Russell 2000® Index is composed of the 2000 smallest companies in the Russell 3000 Index.
MSCI EAFE® Index—The Morgan Stanley Capital International Europe, Australasia, and Far East (MSCI EAFE) Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the US & Canada. The MSCI EAFE Index consisted of the following 22 developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.
Barclays Capital U.S. Aggregate Bond Index—a broad base index, maintained by Barclays Capital, used to represent investment grade bonds being traded in United States. Securities included must be fixed rate, dollar-denominated and nonconvertible. Bonds included span the maturity horizon, although all issues must have at least one year to maturity. All returns are market value weighted inclusive of accrued interest.
Citigroup U.S. 3-month Treasury Bill index—an index that measures monthly total return equivalents of yield averages that are not marked to market. The Index consists of the last three three-month Treasury bill issues.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative (or "informational") purposes only and not intended to be reflective of results you can expect to achieve.
Diversification strategies do not assure a profit and do not protect against losses in declining markets.
The Schwab Center for Financial Research is a division of Charles Schwab & Company, Inc.
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