Devoted to understanding the basics and fundamentals of investing

In the Tale of Alan Delsman, he taught me about the importance of time in realizing your investment goals.  Remember, Alan kept his 401(k) invested in a diversified equity fund and would only look at it once in a very long time.  He was usually surprised by how much money had accumulated.  75% of our colleagues invested in a money market fund so they would always have a positive return.  In investing lingo, they were loss adverse.  Most of us are.  So why was time so important in making stock market returns with their possible losses better than the money market returns that never went down?

Remember in one of my earlier posts, I said that a long term average return for stocks was 10% to 12% depending on the index you used.  But in any given year your returns might be significantly higher or lower.  It turns out that it takes about two units of risk to generate one unit of return in any asset class.  So a stock market index that had a long term return of 12% would have a variance of about 24%.  Normal returns then would vary between 8% and 16% even without unusual economic circumstances.

That is where time comes in.  You need time for the 16% years to average out against the 8% return years.  Given enough time, you will achieve the long term average of 12%.  Business cycles follow the same rule.  Losses during a recession, given enough time, can be made up by out performance in good times.   This tendency to make up losses and generate a long term positive return is a crucial characteristic of the stock market.  I'll talk about why that is the case in my next blog.  In the meantime, remember that the longer you can leave your investment in the market, the more likely you are to achieve the long term results promised.