One thing that has become very popular lately is the “fire and forget” type of investment vehicle called Target Date Funds (TDF). These are funds that invest your savings according to your time horizon: the longer the time you have before you need to draw upon your investments, the larger and more aggressive the TDF’s allocation is in stocks relative to bonds. The less time you have, the smaller the stock allocation becomes. This gradual shrinking of the equity component of one’s overall portfolio is known as the glide path, and it looks something like this (source):
This is because of the historical tendency for stocks to be more volatile, in exchange for a higher rate of return. In any given year, stocks can go up or down 20% (though many late to the game wouldn’t believe the latter is possible), in exchange for an average annual rate of return of 9.60% going as far back as 1928 (source).
Now here’s why longer holding periods matter:
Blackrock calculated that from 1926-2013, the stock market had positive returns 73% of the time and negative returns 27% of the time in any given 1-year period. But if you stretch that holding period to 10 years, the percentage of periods with positive returns goes up to 95%, while the percentage of periods with negative returns plunges to 5%.
Using this back-tested data, financial institutions came up with a way to get people to leave their investments alone and let time do the work by marketing the advantages of a long term approach to investments. As long as people continued to make contributions and didn’t sell out during periods of market panic, the process worked beautifully. The process of dollar cost averaging meant that during weak periods in the market, participants were able to buy more shares when future expected returns were higher (like in 2009), and during strong markets, when future expected returns were lower (like 2015), they bought fewer shares.
And the more investors sat and left things alone, the better they tended to do because they didn’t succumb to the usual cycle of fear and greed…
…which results in what’s known as the Behavior Gap, the observed phenomenon where investor returns tended to do worse than what investments returned :
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