But how quickly do the risks in equity investing diminish over time? Is there some time period after which potential returns from equities outweigh the risk of loss?
Jeremy Siegel, a professor at the Wharton School and author of the popular book Stocks for the Long Run, argues that equities make sense over almost any timeframe, citing the outperformance of equities over bonds based on nearly 200 years of historical data.
Zvi Bodie, a professor at Boston University and an expert on retirement planning, takes the opposite view. Bodie says equities are inherently risky and that risk increases continuously over time. Investors following Bodie’s advice would hold substantially all their assets in Treasury Inflation Protected Securities (TIPS).
Let’s look at time horizons of ten years or more, as this is the focus of retirement-oriented investors. One way to answer the question is by analyzing the historical drawdowns and rallies for U.S. equity investors over various time periods. Industry consultant Ron Surz provides the following data.
For all-equity portfolios, the worst drawdowns were negative for all ten-year time horizons, but for 20- and 25-year time horizons there were no negative returns (that is, the worst drawdowns were positive outcomes). The best rallies similarly occurred over 20- and 25-year periods, easily outdistancing the best outcomes over shorter time periods.
So, for equities, based on this data investors need to have at least a 10-year horizon–and perhaps as long as a 20-year horizon–in order to be confident of earning a positive inflation-adjusted return and having a chance at far superior returns.
Longer time horizons do not mitigate the risk for all-bond portfolios. For holding periods of five years or longer, the worst drawdown is between 40% and 50%. Since these numbers represent cumulative (un-annualized) returns, the risk is lessened with bond portfolios, but it does not go away. “The tendency to recover from the worst isn’t in the bond data,” Surz said.