Stocks Can Be Less Risky Than Bonds
It’s hard to escape the undeniable truth of often repeated truisms, such as you need to balance your portfolio between stocks and bonds. Even for very young long-term investors, financial advisors often recommend allocated some of your portfolio to bonds. Some, like this writer, even recommend owning commodoties to balance your portfolio.
However, this advice doesn’t make sense in the long-run. It’s true that year-to-year different asset classes will outperform, but over the long-run stocks have always outperformed. So, if you want to have more in your basket at the end of the day — and don’t care about short-term fluctuations — there is one asset class you should overweight: stocks. (An aside: commodities have been a horrible long-term investment and should be avoided — especially in times like today, when there is a speculative ferver surrounding them.)
We all know that over the long-run stocks return more than bonds. But few know that stocks are also less risky over the long-run.
The confusion stems from the fact that the risk of stocks varies widely depending on the holding period. While most measures of risk use standard of deviation of return over a one year period, the holding period for long-term investors is often much longer. Even if you are not Warren Buffett — who jests that his favorite holding period is forever — you probably hold you investments for much longer than one year.
In fact, if you are like me and plan to hold your investments at least 15 years, the risk of stocks is similar to slightly below the risk of fixed income investments. See The Future For Investors. In the land of no free lunches, this is a big free lunch for long-term investors.
The true risk (if you believe in CAPM), is the total risk of your portfolio over your holding period. However, the fact that the return is higher and the risk is lower for an asset class means more people should be allocating more of their portfolios to equities. Additionally, the models your financial advisors are using are probably wrong since they use a one-year standard deviation to measure risk and, therefore, overestimate the risk of stocks.
So, if you are a long-term investor, do yourself a favor and allocate more of your portfolio to stocks and less to bonds and commodities.
