The article begins with a literature review concerning the argument that the relative risk of equities declines as the time horizon lengthens, as measured by the probability of equity returns outperforming cash and bond returns. Time diversification is one factor that ameliorates the long-run risk of stocks in that it diminishes the probability of loss as the investment horizon extends. The authors then observe that time diversification leads to the standard recommendation of financial advisors—bank deposits and bonds for short- and medium-term investments, and stocks for long-term investments. An increase in the investment horizon reduces the probability of incurring losses from equity investments; in other words, it reduces the likelihood of stocks underperforming an investment with zero real return. Likewise, a long investment horizon reduces the probability of stocks underperforming other investments with lower returns than stocks, such as bank deposits and bonds (although the probability of underperformance is greater than in the case of a zero-return investment). They conclude, however, that tocks become less risky as the investment horizon extends only for a medium-risk portfolio, such as an index fund. It may even be the case that a balanced fund (equities and bonds) has more time diversification than a 100% equity fund.
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- equity investments
- portfolio management
- time diversification