Investment Duration Is Essential for Investment Return Statistics to Work
by Shane Flait, ©2011

At retirement you have some 20 years or more to invest for income and growth. But what can you expect for returns to counter inflation and market variations?  Let’s look as what investment history has shown us.

The table[1] shows the historical return of some key asset classes as well inflation’s deterioration of the dollar. Inflation’s 3% annual average offsets the other investment returns – their difference gives the ‘real’ return of those investments.  Inflation’s effect becomes significant over long holding times (i.e. investment horizons).

Returns vs Inflation

You can see that treasury bills barely beat out inflation while stocks out did treasury bonds in ‘real’ returns. Small company stocks showed the greatest return.

So, to offset inflation and grow your investments, you ought to go for the greatest returns as shown in the table. But there’s more to the story...

Return vs Volatility

The last column shows investment class’ volatility. It measures how much fluctuation there is in the return compared to its ‘average’ return.  You can see that for all the investment classes the volatility increases with the average return. It’s critical to understand what this implies.

Though large-company common stocks gave an average rate of return of 10.4% for the last 81 years, the actual return each year fluctuated greatly. The best year showed a 54.0% return, while the worst year produced a loss of 43.3%. Volatility clearly poses a significant risk to getting a return at any one time – no matter what the average return expected over the long term is.

However, if you look at all of the five-year investment periods from 1926 through 2006 (i.e. 1926-1931, 1927-1932, etc.), the best return reduces –for that 5 year period - to 28.6% while the worst return produced a loss of only 12.5%. Longer periods (or investment horizons) gives lesser variability, yet the average return overall is still 10.4%.

Your Investment Approach

Based on these historical trends and assuming you diversify within any one class of assets you’re investing in, you can realize the following:

• Volatility reduces for longer holding times (i.e. investment horizons) but poses a serious risk for shorter holding times. So, if you expect to get the high returns for stocks, you must commit to longer holding times to weather those yearly fluctuations that will take place.
• To count on getting returns under a short term horizon, you should stick with investments of lower return – such as bonds – that naturally have lower ‘volatility’ risk. 
• To the extent you can, break up your portfolio between different asset classes – one portion to grow over a long investment horizon and another portion to deliver returns you can more assuredly count on in the short run.

Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com