September 1, 2018

Short-Term Vs. Long-Term Investment Risk: Really Understanding The Difference

“In the short run, the stock market is mostly driven by demand…..causing over- and under-reactions to underlying fundamentals. But in the long-run, the cash-flows that corporations supply are the ultimate drivers of stock returns.”

   FROM “THE LONG-RUN DRIVERS OF STOCK RETURNS: TOTAL PAYOUTS AND THE REAL ECONOMY”PHILIP STRAEHL AND ROGER IBBOTSONFINANCIAL ANALYSTS JOURNAL, THIRD QUARTER, 2017

 

 “Things have never been so good for humanity, nor so dire for the planet.”ARNO KOPECKYGLOBE & MAIL, 25 AUGUST 2018

 

The Quest for Understanding Continues

Recent Letters have addressed the challenges of actually being a long-term investor rather than just  talking like one.i Part of that ‘being’ is to place investment risk in a long-term rather than short-term  context. The February and April Letters began to address this challenge. There is, however, more to be said. Specifically, this Letter addresses two issues:

  1. How time-horizon impacts investment risk: post-WWII stock and bond returns show that lengthening holding periods from a short-term 3 years to a long-term 30 years materially alters the concept of investment risk and the respective roles stocks and bonds play as return generators and risk mitigators.
  2. Identifying ‘Known Unknowns’: foreshadowing prospective long-term investment risks not captured in the post-WWII-to-date investment period.

Before delving into these two issues, we first recap the key risk management messages of the February and April Letters.

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