Risk and your Time Horizon
So far we've been seeing that the stock market is unpredictably risky in the short run.
The good news is that longterm investors get much smoother sailing.
Look what happens to volatility as your time horizon grows from one year, to ten, to fifteen or twenty:
Risk clearly shrinks as your time horizon grows, whether you measure risk by standard deviation or by the painfulness of the actual bad outcomes.
If you're a portfoliochurning short term investor, hurting yourself in the market is as easy as falling off a high and slippery log;
but with a longer time frame, even the worst outcomes are usually better than inflation.
AboveAverage Risk
Strictly speaking, this calculator doesn't show that risk decreases with time;
it shows that that's what has happened in the past, on average.
But there's more to risk than historical averages.
For example, if you buy at a time when P/E ratios are at historic highs, you should expect your returns to be below average.
Here's another example of nonrandom risk.
Set the time horizon for ten years, adjust for inflation, and notice how the pain is concentrated around the inflation of World War I and (worse) the "stagflation" of the 1970s.
There's a lesson here: you don't want the government to deal with deficits by devaluing the dollar.
(This would be a good time to read Free to Choose again.)
Note About Averages
Don't be concerned that the "average" tends to shrink with time in the calculator;
it's just approaching the long term
annualized return rate
(plus or minus some error, since the number of data points isn't constant).
